Thailand’s interest rate policy needs to change

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An image illustrating rising interest rates. Some countries are more successful than others in avoiding runaway inflation. Bangkok Post

On March 16, the Federal Open Market Committee (FOMC), the US equivalent of Thailand’s Monetary Policy Committee, raised its Fed Funds Rate by 25 basis points from 0.00%-0 .25% to 0.25%-0.50% to tame rising inflation.

On April 21, Fed Chairman Jerome Powell said the central bank had pledged to raise rates “quickly” to bring inflation down. He added: “It is absolutely essential to restore price stability.” Most US analysts agree that the Fed will likely raise interest rates six more times this year, taking year-end federal funds rates to 2.5% to 3.5%.

After the interest rate hike by the United States, the Bank of Japan decided to maintain its policy of negative interest rates at -0.1% and confirmed its commitment to buy an unlimited number of bonds for support domestic liquidity.

The Japanese yen has lost 10% of its value since March 16. The sharp depreciation of the currency is one of the prices Japan has paid for not following US interest movements. The 10% depreciation of the currency will mean that Japanese consumers will have to pay 10% more for already expensive imported goods like gasoline. This could push Japan’s ultra-low inflation rate of 1.2% (March 2022) past 3.0%, which is unacceptable for the Japanese economy.

Thailand’s Monetary Policy Committee shared a view similar to that of the Bank of Japan in maintaining local interest rates to support economic growth. The price the Thai economy has already paid is a 3.0% depreciation of the baht and a loss of US$8.72 billion (299.2 billion baht) in foreign exchange reserves (also known as international reserves).

If the Bank of Thailand had not intervened in the market by selling dollars from its reserves, the baht could have depreciated at least as much as the Japanese yen.

The editor once asked me how can I be sure that the Bank of Thailand has intervened in the foreign exchange market to shore up the value of the currency. This is an easy question for an economist to answer, especially if he has experience working with the IMF. I see changes in international reserves, where data is available on a weekly basis. If reserves are falling, it can only mean that the Bank of Thailand has sold its own currency holdings at lower market-determined prices.

Thanks to Bank of Thailand’s rich and up-to-date data reports, I am able to write with 100% accuracy on weekly FX intervention activities. Let me sum up: in the past 12 months, the Bank of Thailand may have used $16.5 billion to support the value of the baht.

Without such interventions during the year, we could have seen a baht/dollar exchange rate above 40 baht per US dollar. Strictly speaking, there is no need to worry about depleting $16.5 billion, or an average of $1.375 billion per month, of Thailand’s net international reserves of $250.4 billion. By IMF standards, Thailand only needs $100 billion in international reserves to be comfortable.

The problem arose after Thailand failed to keep up with rising US interest rates. Last month alone, Thailand reportedly lost more than $8 billion in reserves. The disparity in interest rates is rapidly driving money out of Thailand.

As of May 2, the yield on five-year US government bonds was 2.92% per year, while the yield on similar Thai government bonds was 2.33% per year. Reckless investors who prefer Thai government bonds earn 25.3% less money than those who hold US government bonds, not to mention the potential gain from dollar appreciation. If Thailand’s Monetary Policy Committee does not change its stance on interest rate policy, Thailand could face a financial crisis similar to the 1997 crisis.

The next FOMC meeting has been set for May 3-4 and another rate hike is almost certain. The question is how much? Twenty-five or 50 basis points? Sentiment is leaning towards 50 basis points. Should we therefore expect another major outflow of capital from Thailand in May?

A more interesting question is whether money will continue to flow out of Thailand, in large volumes, until we hit a crisis like Tom Yum Kung in 1997.

Optimistic economists will have two arguments on this issue. First, with current gross international reserves of $233.9 billion, a crisis is very unlikely to occur.

Even if it lost half of these reserves, Thailand would still be fine. Second, foreign investors hold no more than 1.5 trillion baht ($45 billion) in investments in Thai money and capital markets. Even if all these investments left Thailand, the country would still be doing well.

But there are two big misunderstandings on the matter. First, it’s not just foreign money that leaves Thailand. When the money leaves Thailand to seek better returns elsewhere, it does not necessarily belong to foreign investors alone. Thai investors can freely move their investments overseas or invest through foreign investment funds issued by local asset management companies. All investors, Thai or foreign, share a common principle: to seek the best possible return at the lowest possible risk.

Second, the crisis of 2022 (if it occurs) will not be an international reserve crisis resulting from insufficient reserves, but it will be a liquidity crisis resulting from insufficient domestic liquidity. Before investors, Thai or foreign, can move their investments overseas, they must first sell their Thai baht-dominated investment or make cash withdrawals from domestic banks. Such actions would lead to a corresponding reduction in domestic liquidity.

Let me tell you that there is a total of 15 trillion baht invested in the Thai bond/debenture market. If only 10-20% of this amount were to leave the country to find a higher return elsewhere, the country would face a liquidity crisis. Those who lived through the 1997 crisis well understand the great evils of insufficient liquidity. Commercial banks would scramble to raise deposits to offset unexpected withdrawals.

Liquidity wars (deposits) would drive up interest rates. Then, half of the borrowers would be in default because they are unable to service the debt. The economy would then go into depression. It is simply a repeat of the story of the Tum Yum Kung crisis.

What happens if the Bank of Thailand injects cash into the system to replace outgoing money? Thailand will end up like Turkey. Turkey’s central bank is keeping the domestic interest rate at 14% by injecting liquidity into the monetary system despite massive capital outflows. In March, Turkey’s inflation rate was 61% and the Turkish lira lost 80% of its value.

As a member of the international community with an open capital market, I really don’t think the Thai Monetary Policy Committee has a better option than to follow the movements of US interest rates.

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