THE GREAT PANIC OF 2006
The government enacted controls following a massive influx of capital, leading to a stock market free-fall and a swift reversal, writes Oranan Paweewun
Concerns over a widening US current account deficit plagued confidence in US dollar-denominated assets in 2006. Thailand’s current account swung from a deficit of US$3.7 billion in 2005 to a surplus of $3.2 billion a year later, attracting an influx of capital flows into Southeast Asia’s second-largest economy.
Offshore inflows into the Thai equity and bond markets were enormous in October and November 2006. The capital inflows picked up their intensity in the first week of December, reaching $950 million a week from an average of $300 million in November.
The baht performed a stunning about-face in 2006, with the surge of capital inflows turning it into the best-performing currency in Asia from the region’s worst a year before, which was partially because of effects from the 2004 tsunami.
The currency appreciated by nearly 15% to a nine-year high of 35.06 to the dollar on Dec 18, 2006, from 41.04 at the beginning of the year. Such a rapid gain stoked policymakers’ fears that exports, which make up 70% of Thailand’s GDP, would lose competitiveness to rivals.
After the stock market’s close on Dec 18, 2006, MR Pridiyathorn Devakula, the deputy prime minister and finance minister under Gen Surayud Chulanont’s military-backed government, spooked investors by imposing Chilean-style capital controls in the form of an unremunerated reserve requirement via a withholding tax of 30% on all currency exchanged for baht, aimed at stemming hot money and curbing the baht’s ascent.
Under the capital controls, foreign investors bringing more than $20,000 into Thailand were required to deposit 30% into a non-interest-bearing account at the Bank of Thailand for at least one year, unless it was related to trade activities. Foreign investors had only 70% of their deposit to invest in Thailand, with earlier redemptions receiving only two-thirds of their deposited funds.
“The baht has been moving only one way as other currencies have fluctuated up and down. If we didn’t break the momentum, we don’t know where the rate would end. We aren’t looking to help exporters, just to reduce volatility. Data shows exports are growing by double digits. But these are all advance orders and margins have shrunk,” Tarisa Watanagase, the Bank of Thailand governor, told the Bangkok Post in an exclusive interview on Dec 25, 2006, explaining why the capital controls were necessary.
The SET index fell 68 points on opening on Dec 19, 2006, forcing the Stock Exchange of Thailand to implement a 30-minute circuit-breaker — used when the index declines 10% in a day — for the first time in its history.
After trading resumed, the SET slid further to nearly a 20% decline before rebounding in afternoon bargain-hunting. At the market close, it had shed 108.41 points or 14.84% — the biggest oneday drop ever, with foreign investors yanking out 25 billion baht from the Thai stock market and investors losing 820 billion baht of wealth in a single day. Losers outpaced gainers 460 to eight, with 34 stocks tumbling more than 10%.
The sharp retreat in the Thai stock market had a spillover effect on other bourses in Asia. The Malaysian and Singaporean stock markets fell around 2% and Indonesia’s slumped almost 3%. The draconian capital restrictions were reminiscent of the 1997 Asian financial crisis, triggered by the devaluation of the baht.
The stock market free-fall forced Thai authorities to reverse some of their harsh measures, exempting equity investment from the 30% reserve requirement imposed a day earlier, though it remained in place for bond and money markets.
On Dec 20, 2006, the Bangkok Post quoted MR Pridiyathorn as acknowledging the capital measures had a “stronger than expected” impact on the equity market.
“Investors panicked. But we need to accept losses [in the market],” he said. Despite the market implosion, MR Pridiyathorn defended the measures, noting that over the previous three weeks huge capital inflows had been building up in the short-term debt market for currency speculation.
“Foreign speculators were going to take advantage of the country, so the central bank had to issue measures to counter this,” he said.
Nitaya Pibulratnagit, a central bank assistant governor at that time, said it imposed a blanket rule on foreign exchange transactions because of the difficulty in tracking where speculative funds are held.
“Foreign funds appear to be dispersed all over, including bonds, stocks and commercial paper. It’s difficult to target specific markets,” she said.
Despite the severe side-effects, the harsh measures slowed the baht’s appreciation. The currency rose by 7% in 2007 for a total gain of 15.47% from 2005 to 2007. This was a bit higher than other regional currencies, as China’s yuan increased 13.31%, the Singaporean dollar 13.3% and the Malaysian ringgit 14.6%.
After 15 months, the capital controls were abandoned in March 2008 and authorities have since chosen to relax regulations governing capital outflows to rein in baht appreciation rather than imposing capital restrictions.