Baht's volatility a sign of Kingdom's growing integration in global markets

In mid-April, the dollar-baht exchange rate hovered around 28.6. At that level, it had appreciated by a whopping 6.7 per cent since the start of the year – much more than any other Asian currency, and actually one of the best performers in the world. 

Foreign investors were piling into Thailand, Thai exporters went into shock and a fierce debate was raging among policymakers on whether to cut interest rates. 

Financial markets can shift rapidly, but the movements of the past two months have been even more extreme than anyone ever expected. The baht has completely reversed direction and in fact it has weakened much more quickly than it had strengthened. By early this month, the baht had moved back above 30.6, where it had begun the year, and then even briefly passed the 31.0 level. 

The reversal was partly due to aggressive comments from Thai authorities, including some very public preparations of capital controls. It was also partly due to a big shift in global market sentiment, with investors heading back to the US dollar after surprisingly conservative policy signals from the United States. 

The root factor is that Thai financial markets have become much more integrated with global markets over the past few years. Foreign participation in Thailand has surged and that makes local prices and rates much more dependent on shifts in global investor sentiment. 

One obvious question is whether this dependence is healthy or sustainable. If foreign flows are so disruptive to local markets, then should we “opt out” of this international system?

Not necessarily – there are also some very positive implications of greater foreign flows. Increased interest in local markets has contributed to the surge in the Thai stock index, which even with the recent correction is still up sharply over last year. Foreign purchases have also led to much lower bond yields, helping to drastically reduce costs for Thai bond issuers – including the government!

There are also products that can reduce the risks of market volatility. For example, foreign exchange risks can be hedged through currency derivatives. Banks and regulators will have to ensure that such products are easily accessible to all, including smaller companies. 

Another important factor is financial market regulation. Nervous and shifting policies can exacerbate the market’s volatile tendencies, while a steady hand can have a calming effect on sentiment. In these times, it remains even more important to have a credible and strong central bank. 

In the meantime, market volatility should continue, particularly as investors are still unclear about the monetary policy implications of the major economies. 

The Federal Reserve – the central bank of the United States – is starting to suggest that it would like to downshift its monetary easing programme. If its QE3 bond-buying programme is indeed reduced, although this still looks uncertain, this could be a big driver for the US dollar to strengthen. 

There is also much ambiguity from Japan. The Bank of Japan’s announcement in early April of its aggressive easing plans led to a huge bout of yen weakness. But more recently, there are renewed doubts about the commitment of the Japanese authorities and their ability to cook up greater inflation. 

In this environment, fickleness in investor sentiment, and in the baht, appears likely to persist, with the key drivers continuing to come from abroad. Everyone is going to have to hang on for the ride. 

 

 

_ Parson Singha is chief global market strategist at HSBC Thailand