One year after the capital controls

One year after the capital controls
The appreciation of the baht over the past year has had a huge impact on, and created several complications within, the Thai financial system.

Published on December 17, 2007


The Bank of Thailand has faced a dilemma over its attempt to stem the baht's rise by introducing the 30-per cent reserve requirement and by actively intervening in the foreign-exchange market. By doing so, the central bank has suffered big losses on its balance sheet. (In a way, the central bank's debt also represents the country's debt because in the end the government may have to pay off this debt if necessary.)

But the central bank did not have much of a choice and appears to have done its best to manage stability. By intervening in the foreign-exchange market by buying up the US dollar, the central bank has accumulated dollar reserves. This has resulted in a new challenge of how to most efficiently manage the reserves.

This article will not touch on the 30-per cent reserve requirement, nor will it discuss the central bank's foreign-exchange intervention, because both of these have already been widely debated. I would rather focus on the central bank's losses from its foreign-exchange intervention, and secondly on the implications of these losses on the economic and financial system as a whole.

Last year, the central bank reported losses of about Bt170 billion from its foreign-exchange intervention. This brought its accumulated losses to Bt95 billion and sent its net worth to negative Bt70 billion. This year, the central bank's losses should be around Bt58.15 billion based on the Revaluation of Average Cost of Reserves Method, assuming that the central bank holds 60 per cent of its reserves in US dollars and the remaining 40 per cent in euros. Based on the average return of the US Treasury, the central bank earns about 4 per cent from this investment. It also has a cost of about 3.5 per cent a year from its outstanding bonds issued to mop up the liquidity from the financial system.

The central bank's losses this year are calculated from existing losses of Bt80.4 billion; losses of Bt7.85 billion incurred as a result of the increase of the foreign reserves during the year; and losses from the currency swaps of Bt20.76 billion. When returns of Bt103.36 billion from the reserves and the cost of the central bank's bonds of Bt52.50 billion are taken into account, the central bank's losses this year should stand at around Bt58.15 billion.

So what are the implications of the central bank's losses? I have based my study on academic studies such as "Central Bank Loss and Economic Convergence", "Capitalising Central Bank: A Net-worth Approach", "Does the Central Bank Need Capital?", "The Role of Central Bank Capital Revisited and Seigniorage", and "Central Bank's Profits, Capital and Creditability". These studies have found that the central bank's negative net worth and chronic losses could affect its monetary-policy management. As a result, it might find its credibility at risk and its ability to manage inflation weakened. It might also find itself less effective in supervising financial institutions in terms of injecting liquidity or lending money to them. The central bank's chronic losses might place a burden on the government budget, which may need to help the central bank increase its capital to restore confidence.

Most importantly, the central bank's losses might impair its independence in managing foreign-exchange reserves and running monetary policy because the government might step into the central bank's domain to prevent losses from occurring in the future.

However, in the case of the Bank of Thailand, its losses and its negative net worth have not hurt its ability to manage monetary policy. The Thai central bank still manages inflation pretty well. But it faces a huge communication gap in creating better public understanding of its losses.

Over the past one to two years, the central bank has issued bonds worth about Bt1.5 trillion to absorb liquidity from the financial system as a result of its foreign-exchange intervention. It might need to issue another Bt500 billion, bringing the total bond outstanding to Bt2 trillion. This amount is equivalent to 20 per cent of the gross domestic product and is two times larger than the money circulating in the economic system.

As the value of US dollars in the reserves is likely to fall in line with US fundamentals, coupled with the central bank's Bt1.2 trillion burden from bailing out the financial system in 1997, it is unlikely that the central bank will be able to pay off its debt over the next 15 years. With the weakening US dollar, the central bank will also have to keep on buying up the dollar to keep the baht from rising too high and also to issue bonds to borrow the baht for its intervention. Nobody knows when this dilemma will end. But the central bank may sell off its reserves periodically to raise money to pay off its debt.

Dr Chodechai Suwannaporn