The dilemmas caused by volatile FX and interest rates

It was in 1997 that the baht was forced off its fixed exchange rate to float along with market forces. But surely since then the central bank has also been there helping to keep watch, preventing the baht from becoming too volatile and making sure that movements are mostly in line with our neighbouring countries.
But times have changed. We are living in a world with massive liquidity in global financial markets, with the major central banks aggressively printing money. And in this environment relentless movement in the capital account – investments and loans – are driving big shifts every day in currencies.
With these shifts some will gain and some will lose – inflows are helping baht bond yields fall dramatically, they are helping importers save costs, they are helping to keep inflation low. But at the same time, exporters, who saved this country after 1997, are facing hard times and falling profits and will have to adjust.
Of course, all this has come to the attention of those in authority.
The disagreements are obvious. Many policymakers want the baht to be much weaker and interest rates to be much lower. They are very unhappy with the central bank for failing to follow their recommendations. And they have expressed this unhappiness many times publicly and presumably privately.
It is not a stretch to argue that this situation itself has caused much volatility, as people worry about the potential impact of the drastic measures being discussed such as capital controls and sharp rate cuts. And these worries are also impacting the forex and local interest rate markets.
But the market atmosphere is uncertain also because these disagreements have reached unprecedented levels – official letters have been sent, threats have been issued and special meetings have been called to ensure that the views of the Finance Ministry are crystal clear to the Bank of Thailand.
With this clarity there is not yet agreement, as the central bank is still obviously sceptical about the necessity of interest rate cuts. However, this scepticism may change if global economic conditions continue to worsen. And indeed there are some warning signs and some central banks have turned more cautious.
Yet, what might happen if the wishes are granted?
What to do? Cut rates? That would boost short-term growth. But wouldn’t exceptionally low rates also cause |even more credit growth in the economy, at a time when financial system lending is already high and already supportive of the country’s economic growth?
And actually, if things do turn out all rosy, and Thailand’s economy prospers further, wouldn’t that attract even more capital inflows and lead to even greater pressure on the baht to abnormally strengthen?
Then again, capital inflows into bonds are helping to keep bond yields, and the government’s borrowing costs, low. But can these yields remain low if investors are not confident about the country’s long-term macroeconomic stability, or if global investor sentiment is hit by regulatory limitations on capital flowing into Thailand?
And then, we are back to the original dilemma. Is there a way to have excellent growth, a stable financial sector, muted inflation, low bond yields and a weak currency? And perhaps a cherry on top?
Beware – we may then be living in a dream, and then suddenly wake into the real world.

Parson Singha is chief markets strategist at HSBC Thailand.