Thai central bank faced with too many dollars

The central bank has US$185 billion in reserves, along with US$27 billion in net forward contracts, leading to a net surplus position of US$212 billion. That’s up sharply from US$154 billion in the beginning of 2010, or $118 billion at the beginning of 2009.
This is a lot of money – but it is a burden rather than an indicator of wealth. 
That’s because the reserves are backed not by accumulated profit or capital, but by liabilities and debt.
Most of these foreign reserves were acquired by selling the baht in exchange for other major currencies. These foreign exchange transactions were done primarily to reduce the volatility, or influence the direction, of the baht exchange rate.
Therefore, while the balance sheet of the central bank has large amounts of foreign-currency assets, it also has huge amounts of domestic-currency liabilities as well.
This has had a couple of implications.
First, the baht has been consistently strengthening – it appreciated 4 per cent in 2009, and 11 per cent during 2010. This means the value of foreign currency assets, in baht terms, has declined drastically – the central bank incurred net foreign exchange losses of Bt104 billion in 2010.
Second, relative interest rates are unfavourable. Continued economic weakness means that risk-free interest rates for major currencies such as the dollar and the euro are near all-time lows. At the same time, baht interest rates have been increasing. This leaves the central bank with low returns on its foreign-currency assets, and comparatively higher costs on its domestic liabilities.
The baht exchange rate has been more stable this year, so hopefully such large exchange-rate losses will not recur. However, global interest rates still look likely to be very depressed for some time, particularly with the Federal Reserve (the United States central bank) poised for more stimulus measures such as increasing its money supply.
One alternative would be to try to increase the returns on assets. However, any higher returns would likely have to be accompanied by increased risks and volatility. 
Asian countries are known for having high reserve levels, but Thailand has been pulling ahead. Thai reserves now total 58 per cent of GDP – compared to 55 per cent in Malaysia, 54 per cent in China, 31 per cent in Korea, and 14 per cent in Indonesia.
Thailand’s foreign reserves are excessive by other measures as well. The country has little foreign currency debt, while reserves now exceed twelve months of the country’s imports.
There are fundamental reasons for Thailand’s increasing reserves: an excess of domestic savings over investment (leading to consistent balance of payments surpluses), as well as a local financial infrastructure that does not encourage the private sector to hold foreign assets.
Hence, the ultimate way to smoothen out Thailand’s excess reserve accumulation is to encourage greater balance in the economy – by promoting domestic investments, and by giving greater regulatory leeway to the private sector.

Parson Singha is chief markets strategist, Global Markets Department, HSBC Thailand.