Capital inflows keep flooding into thailand

New money injected into the global economy at the rate of US$85 billion (Bt2.5 trillion) a month from the US and $75 billion from Japan have created a global imbalance and caused fluctuations in the global financial market.

Thailand has become a parking lot for the inflows due to the higher return from its bond market and stronger economy fundamentals than other Asian countries. Thailand would continue to face inflows during the next one to two years and the concern over the baht’s appreciation would become a main factor in any future economic measurements.

Cutting the policy interest rate – the overnight repurchase rate – to slow down the capital inflows has become the hottest issue in the Thai financial market. However, there are four important facts that investors should know in considering the appropriateness of this move.

The policy rate is a reference for "short-term" interbank lending and statistics show no correlation between a cut in the policy rate and a reduction in the yield of "long-term" bonds. Foreign investment in the bond market since January has been mainly in long-term bonds, so cutting the policy rate wouldn’t douse the interest to invest in the Thai bond market.

However, if cutting the repo rate caused a reduction in the yield of long-term bonds, this would encourage capital to flow out of the Thai bond market. This is because the reduction in yield translates into an increase in the value of any long-term bond. This gain from the change in prices will encourage foreign investors to sell their bonds and leave the bond market, leading to a fluctuation in the exchange rate.

The repo rate also acts as a reference for banks in setting their deposit and loan rates. If the repo rate falls, banks will cut their deposit rates, forcing savers to move their money to other channels. Lenders also tend to step up their lending with a lower loan rate. This may speed up economic bubbles.

And the most important point is, what’s the proper depth of an interest rate cut? Now the interest gap between Thai bonds and American and Japanese bonds is in the range of 2-2.5 percentage points. A dent of only 0.25-0.5 point in the repo rate wouldn’t stem the inflows.

With these current concerns in the Thai financial market, foreign investors have continued to be net buyers of Bt84.47 billion in the bond market – Bt38.28 billion in short-term bonds and Bt46.18 billion in long-term bonds. At the same time, they have been net sellers of Bt19.8 billion in the Thai stock market.

The Thai yield curve moved in a narrow band last month, shifting down in a range of 1-25 basis points. Most trading activities have been concentrated in Bank of Thailand notes.

Turnover in the secondary bond market reached Bt2.03 trillion last month, or a daily average of Bt106.83 billion, increasing 6 per cent from March’s daily average of Bt100.79 billion. More than 60 per cent of daily trading, or Bt64.34 billion, was in bonds of less than one-year maturity.

The major investors in the Thai bond market were still asset management companies, which accounted for 51 per cent of total trade, while foreign investors were 21 per cent, or Bt268.01 billion. At the end of last month, foreign investors’ holdings were Bt883.9 billion, accounting for 9.9 per cent of the bond market – well above the Bt710.5 billion level at the end of last year.

nPorpit Yodsang is the assistant manager of the research and development department at the Thai Bond Market Association. He can be reached at [email protected] or 02-252-3336 ext 213.