Thailand's foreign exchange reserves may have peaked

Dr Virabongsa Ramangura, the chairman, has revived his call for the central bank to review its inflation targeting policy. He also wants the central bank to release a significant portion of its foreign exchange reserves of about US$178 billion to the government, so that it can use the money to invest in infrastructure development projects worth Bt2.2 trillion – to help fulfill Thailand’s ambitious leadership role in the Asean Economic Community.

Revising the inflation targeting policy is debatable. Dr Virabongsa would like the central bank to target exchange rates or, to a lesser extent, economic growth because the world is now facing deflationary pressure. 

Dr Supavud Saicheua of Phatra Securities also supports a policy departure from inflation targeting to exchange rate targeting. Inflation would not be a problem, as global assets might have to go under fire sale in the event of a worsening euro crisis and global slump.

Dr Prasarn Trairatvorakul, the BOT governor, has come out to defend the inflation targeting policy, saying that this policy tool is appropriate enough to look after economic growth and stability. The central bank has departed from the fixed exchange rate system and is now adopting quite a flexible exchange rate regime. It does not hesitate to step in to intervene in the foreign exchange market to keep the baht stable. Also, it is reading to the act on the interest rate policy to manage growth and stability.

I have talked to Dr Virathai Satipraphop, a well-known economist, and he is more inclined to support the inflation targeting policy, arguing that the core inflation rate of 0.5 per cent to 3.50 per cent is broad enough for flexible management.

More controversial is Virabongsa’s call for the utilisation of the central bank’s foreign exchange reserves to support the government’s fiscal needs for massive infrastructure investment. The idea is that Thailand has too much in reserves, largely denominated in US dollars. The reserves should be used to spur investment and create growth rather than letting them sit idle. Dollar reserves or other assets from the OECD are yielding very low interest rate returns. They also represent paper assets.

Prasarn is fighting hard against this move to use the reserves. In a diplomatical gesture, he said the government may use the reserves by using the baht or issuing bonds to exchange for the dollar reserves with the central bank. In other words, there is no free lunch.

The central bank also carries a huge cost in managing the reserves because when it uses the baht to purchase dollars, it has to issue Bank of Thailand bonds to mop up baht liquidity from the system.  This sterilisation operation is rather costly and has become a burden to the central bank.

A research paper from Citibank, “Have Asia’s Foreign Exchange Reserves Peaked?”, shows that Thailand and other countries might have passed the optimum peak in their foreign reserves accumulation due to a deterioration in the current account and foreign direct investment. “With Asia’s basic balance, current account plus net foreign direct investment, deteriorating by 35 per cent in 2012-2013, a more cautious outlook on capital flows suggest high risk to continued reserve deterioration unless the currency is allowed to adjust more,” Citibank said. It sees the biggest downward pressure on Indonesia, India, Sri Lanka and, to a lesser extent, South Korea and Thailand.

If Thailand has passed the optimum peak in its foreign exchange reserves accumulation, then it would be rather worrisome if the government were to force the central bank to release the reserves to it for infrastructure investment. The terms of trade are changing rapidly. The export growth target of 15 per cent, forecast since the beginning of the year, has now been revised downward by half to 7 per cent. Some private economists say export growth in 2012 could be just 5 per cent.

Moreover, Thailand’s service account is also losing ground in spite of a high trade balance. Overall, this year’s current account suplus is likely to fall to $300 million, compared to more than $20 billion four or five years ago.

If this pace of current account deterioration continues, we should think twice about any temptation to use the reserves, which exist to guarantee Thailand’s wealth, credit-worthiness and the baht’s stability. That said, the central bank should also consider diversifying the portfolio of its reserves to add more gold, and conduct an additional bilateral currency swap agreement with China.