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The curse aka politics!

Dec 20, 2006

As a way to 'quickly restore confidence' and pare the 'damage' done by its central bank, the military-backed Thai government has scrapped currency controls on international investors just a day after the country's central bank had imposed them thus leading to a sharp plunge (biggest in 16 years) in the Thai stock market. Readers should note that following the announcement from the central bank, which read that international investors must pay a 10% penalty unless they keep funds in the country for a year, Thai stocks witnessed an erosion of almost US$ 23 bn in market capitalization in a single trading session. What's more, these currency controls triggered declines in other emerging stock markets as well (see adjacent graph), thus highlighting the risks inherent in emerging market equities.

As the Thai central bankers must have watched in awe, the country's government announced the removal of the requirement that banks lock up 30% of new foreign-currency deposits for a year, citing that 'the stock market has fallen too much today!' In a truly political tone, the finance minister clarified that the stock market fall was a side effect of the central bank's measure, and that "he has fixed it already." As reported, the rule would have limited international investors to using 70% of their funds to buy Thai stocks, as also bonds and property. While removing the control on equity investments, the Thai government has indicated that controls shall stay in effect on other investments like bonds and property.

As a matter of fact, the Bank of Thailand (Central bank of Thailand, or BoT) had imposed currency controls after the Baht appreciated to the strongest in nine years, even though the central bank had recently introduced steps to limit the currency's gains. Readers would do well to note that an export-dependent economy like Thailand (exports were 81% of total GDP in 2005) would feel a greater pinch from currency appreciation than an economy that is internally driven (like India, that exports less than 14% of GDP). This is because currency appreciation makes exports uncompetitive and has a great impact on growth of such economies. The Thai Commerce ministry already expects the country's export growth to slow to near 10%-12% in 2007, from the 16% growth that is expected for this year. Following the Thai central bank's announcement of restrictions on short-term foreign capital inflows, the Baht had the biggest two-day decline since April 2005.

Thailand's economy is much like India's, or vice versa. Both the economies have the largest chunk of population dependent on agriculture yet the biggest contribution to GDP coming from the services sector (52% for Thailand and 60% for India). Both the countries are almost at similar stage of development and are a 'hungry' lot as far as capital requirements are concerned. This hunger for growth capital has led to the countries attracting a lot of foreign funds, although more in terms of portfolio and less in terms of direct investments.

As a result of flow of cheap global money in the past 2-3 years, the stock markets of both the countries have 'benefited' tremendously. In the past 2 years, the Indian BSE-Sensex has gained 109% point to point. However, this influx of funds from global investors (which includes more of short-term than long-term funds) has had its consequence in strengthening the Baht, which has significantly hurt Thai exports. The BoT's announcements of controls on short-term foreign money were, thus, directed towards curbing the 'menace'. However, the speed at which the policy has been reversed might go a long way in impairing the BoT's credibility.

Lessons for India
As has been indicated above, as also in an earlier article, the country has attracted a lot of foreign capital (more of the portfolio type) in the past 2-3 years. "But everyone in this country seems scared to distinguish long-term capital from short-term capital. Any Foreign Institutional Investors (FIIs) buying is seen as a vindication of economic success when, in all likelihood, much of this inflow is the effect of cheap global money. The cost of speculation is close to zero for most global hedge funds." The Indian central bank, the Reserve Bank of India (RBI), has sounded alarm bells in the past with respect to curbing the flow of 'non-serious; short-term money through strict controls, but in the process, has received flak from the Finance Ministry.

If only India was as brave to take steps against speculative foreign capital flows and other forms of short-term capital. But no one wants to be blamed for 'killing' the stock market. Are we ready to pay the price? Will we be at least forthcoming to 'regulate' rather than 'license'? If Ms. Watanagase can do that, so can Mr. Reddy!

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