VZCZCXRO8995
RR RUEHCHI RUEHDT RUEHHM RUEHNH
DE RUEHBK #2392/01 1170732
ZNR UUUUU ZZH
R 270732Z APR 07
FM AMEMBASSY BANGKOK
TO RUEHC/SECSTATE WASHDC 6509
RUCPDOC/USDOC WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASH DC
RUCNASE/ASEAN MEMBER COLLECTIVE

UNCLAS SECTION 01 OF 05 BANGKOK 002392 
 
SIPDIS 
 
SENSITIVE 
 
SIPDIS 
 
STATE FOR EAP/MLS AND EB 
COMMERCE FOR EAP/MAC/OKSA 
TREASURY FOR OASIA 
STATE PASS TO USTR FOR WEISEL 
STATE PASS TO FEDERAL RESERVE SAN FRANCISCO FOR DAN FINEMAN 
STATE PASS FEDERAL RESERVE NEW YORK FOR MATT HILDEBRANDT 
 
E.O. 12958: N/A 
TAGS: ECON PGOV PHUM PREL TH
SUBJECT: CORRECTED COPY: BAHT APPRECIATION, CAPITAL CONTROLS AND 
EXCHANGE RATE POLICY 
 
SENSITIVE BUT UNCLASSIFIED HANDLE ACCORDINGLY 
 
REFTELS: 
A) BANGKOK 1399 THAILAND'S NEWLY APPOINTED MINISTER OF FINANCE 
B) BANGKOK 1809 BANK OF THAILAND'S LATEST EFFORT TO STOP THE BAHT 
C) BANGKOK 499 RECENT THAI ECONOMIC POLICY - WHY? 
D) BANGKOK 1702 PROSPECTS FOR THAILAND'S 2007 ECONOMIC GROWTH 
 
¶1.  (SBU) Summary: Last December, the Bank of Thailand (BOT) imposed 
controls on capital inflows blaming foreign speculators for 
appreciating the baht and reducing the competitiveness of Thai 
exporters.  However, Thailand continues to face strong appreciation 
pressures on its currency but, at least since the start of the year, 
not due to speculative capital inflows but rather from activities 
related to the nation's trade account.  Exporters are driving baht 
appreciation as imports have fallen to a level insufficient to 
offset exporters' demand to buy baht.  The drop in imports is due to 
depressed domestic demand brought on primarily by ongoing political 
uncertainty as well as heightened regulatory risks stemming from 
capital controls and proposed revisions to Foreign Business Act 
(FBA).  Thus capital controls, while stemming inflows, have had the 
unintended consequence of also aggravating appreciation pressures on 
the baht.  BOT Governor Tarisa has acknowledged exporters' role in 
driving baht appreciation, but continues to focus public attention 
on speculative activity as a source of appreciation.  Given this 
focus, the BOT is not aggressively pursuing market based solutions 
that would address the fundamentals of baht appreciation, although 
it has implemented a few incremental measures. 
 
¶2.  (SBU) Justified in the name of exporters, there is little 
discussion of the costs and benefits of keeping the baht 
depreciated.  The various measures to stem appreciation - 30 percent 
reserve requirements on non-equity or non-hedged foreign portfolio 
inflows, and BOT's heavy intervention and sterilization activities 
in the f/x market - are not costless.  The BOT is taking losses on 
its balance sheet, cost of funds are higher than without capital 
controls, and exporters are not being sent the appropriate price 
signal to improve productivity and move up the value chain as is 
needed to stay competitive, particularly as competition from China 
and Vietnam increase.  Further, the benefits are not clear as only a 
relatively narrow group of exporters, but those in sectors with high 
levels of employment, appear to be the most vulnerable to baht 
appreciation.  Also, capital controls appear to be a moral hazard as 
exporters hedged less foreign exchange risk immediately following 
capital controls.  Public discussions on the baht have been 
distorted as they are overly-focused on the baht's 2006 nominal 
appreciation against the USD, despite evidence that on a real basis 
in the medium term the baht remains competitive and has moved in 
line with other regional currencies.  End Summary. 
 
 
Exporters the Primary Driver of Baht Appreciation 
--------------------------------------------- ---- 
 
¶3.  (SBU) While both the current and capital account were sources of 
appreciation in 2006, since the start of 2007 exporters have been 
the main driver of baht appreciation.  In January, the most recent 
data available for 2007, exports rose 17.8 percent y/y to $10.4 
billion, but imports slowed to a 4 percent y/y growth, contributing 
to a widening current account surplus of $1.54 billion in January 
after a surplus of $1.22 billion in December and a surplus of $1.51 
billion in November.  Comments by BOT officials, including Governor 
Tarisa, and Ministry of Finance (MOF) officials, indicate that 
exporter's continued to be the driver of appreciation in February 
and March as well. Bankers have been telling us for some time that 
exporters were the key factor in the baht's appreciation (reftel 
499). 
 
¶4.  (SBU) Without strong imports, exporters will continue to be a 
significant source of baht appreciation.  Imports have fallen due to 
depressed domestic demand brought on primarily by ongoing political 
uncertainty as well as heightened regulatory and policy risks 
stemming from capital controls and proposed revisions to Foreign 
Business Act (FBA).  Historically, exporters' foreign exchange 
earnings have largely been offset by imports of raw and 
semi-finished materials, capital goods and consumer goods. This is 
reflected in Thailand's relatively small average trade surplus (0.4 
percent of GDP per year on average for the past 5 years). With the 
decline in consumer and business confidence, capital goods and 
consumer goods imports have been flat to down so export earnings are 
simply converted into baht. 
 
BANGKOK 00002392  002 OF 005 
 
 
 
¶5.  (SBU) Exporters' need to sell foreign exchange earning will 
remain large, as exports equal 60-65 percent of GDP (twice the 
average of middle income countries) and is targeted by the 
government to grow 12 percent in 2007.  The National Economic and 
Social Development Board, the Thai government's main economic 
statistics and forecasting body, forecasts 2007's current account 
surplus at $3.1 billion (1.6 percent of GDP).  However, some private 
sector analysts have placed their forecasts higher, with Credit 
Suisse forecasting a 2007 current account surplus of $8.4 billion 
(3.5 percent of GDP). 
 
¶6.  (SBU) Further, exporter's pressure on the baht is aggravated by 
BOT regulations on exporters' foreign currency holdings.  An 
exporter may freely hold up to $2 million in foreign currency.  Any 
amount above that must be exchanged for baht within 15 days, except 
amounts for which the exporter presents proof that the foreign 
currency is to be used to satisfy a foreign currency obligation 
coming due within 6 months. 
 
 
But Governor Tarisa still Directing Public Attention on Speculators 
and Capital Inflows 
-------------------------------------------- 
 
¶7.  (SBU) BOT Governor Tarisa has made remarks acknowledging that 
exporters are the current source of appreciation.  However, with 
exporters the only engine of growth, and the justification for 
December's controversial capital controls, Governor Tarisa appears 
reluctant to focus public attention on this dynamic.  Instead, she 
continues to focus on the role of speculative activities and foreign 
inflows as driving baht appreciation. 
 
¶8.  (SBU) Recently, as noted in Reftel 1809,  Governor Tarisa called 
on commercial banks to stop taking foreign exchange positions that 
the BoT argues were putting upward pressures on the baht, noting 
that some had been taking larger positions than prudentially allowed 
(20 percent of assets) -and thus "manipulating" the currency.  The 
BOT is now requiring that banks submit their foreign exchange books 
on a daily basis (prior they were submitting on a weekly or 
bi-weekly basis).   However, closing banks' foreign exchange 
position has had only a minimal effect on the baht.  The BOT's 
active foreign exchange intervention (see following section) has 
been the main factor in keeping the baht depreciated. 
 
¶9.  (SBU) In her most recent public speech on March 16th to the 
Japanese Chamber of Commerce, Governor Tarisa focused on speculation 
and foreign capital inflows as drivers of appreciation.  She stated 
an "unwarranted strengthening of the currency ... prompted the 
introduction of the capital controls" and referred to the 
vulnerabilities of Thailand's economy and the risk to its economic 
stability from "fast-moving" international capital.  She made no 
mention of the current account's contribution to 2006's appreciation 
($3.2 billion surplus from a $7.8 billion deficit in 2005) nor the 
export driven appreciation of 2007. 
 
More Market-Based Solutions - Liberalization of Outflows 
--------------------------------------------- -- 
 
¶10.  (SBU) Analysts here believe there are other actions that the 
BoT should be pursuing to limit further baht appreciation. First, 
the BOT could more aggressively pursue liberalization of capital 
outflows, as other countries in the region, notably Korea, have done 
to stem appreciation pressures on their currencies.  Recently a 
Finance Ministry spokesperson, in calling for an increase in capital 
outflows, noted that not enough has been done to simplify the 
process for sending money abroad. 
 
¶11.  (SBU) The BOT maintains a $50 million per investment/pension 
fund limit on outward bound investment. Insurance companies have 
their own limits based on approvals from the Department of 
Insurance.  Some analysts maintain that a bold policy move - 
complete removal or aggressive increase in this cap - would send a 
positive signal to markets that the BOT is seeking more market-based 
solutions and address fundamentals of baht appreciation.  Removal of 
the cap will not have an immediate effect, as only a few large 
investors are constrained by this ceiling.  However, greater 
liberalization of capital outflows could provide incentive for the 
private sector to more actively provide and market international 
funds to middle-class investors, thus propelling investor education 
and outflows in the medium term.  Thai investments outside the 
 
BANGKOK 00002392  003 OF 005 
 
 
country are small, as Thais have tended to be conservative 
investors, not accustomed to investing outside the country. 
 
¶12.  (SBU) However, aggressive liberalization of outflows appears to 
not be BOT a priority, although they have incrementally raised the 
cap over the past few years (prior to 2003 investment outflow was 
not allowed).  Anecdotally, BOT officials merely cite that high-net 
worth Thais who wish to invest internationally already do so through 
work-around solutions.  Funds may apply to the BOT for the cap to be 
raised on a case by case basis.  These officials point out the $50 
million cap per fund on outflows is not a hard constraint.  Despite 
awareness of the leakages, there appears to be a strong desire at 
the BOT for such regulations to remain so that Thailand has a 
defense measure in place in case of a large disruptive capital 
outflow.  In interviews, mid-level managers noted that if the caps 
were completely removed, the BOT would have no tool to deal with 
such an economic shock. 
 
More Currency Hedging, Less Moral Hazard 
---------------------------------------- 
 
¶13.  (SBU) A mid-level BOT official noted in conversation that 
exporters are not sufficiently knowledgeable of foreign exchange 
hedging products.  The BOT could do more outreach to help educate 
exporters and to facilitate the development of foreign exchange 
hedging products for them.  Public data is not available, but 
according to a presentation by a BOT researcher, exporters' hedging 
ratio has risen from 5 to 10 percent in 2001, to 15-20 percent in 
2003, surged to 35 percent in 2004, and has since fallen to 15-25 
percent in 2006 and early 2007.  Recent quotes in local press by 
head of capital markets at Kasikorn Bank, verify exporters' recent 
low hedging ratio.  He noted that exporters hedge fewer than 40 
percent of their total transactions on average.  He stated that in 
January, the cover ratio fell to just 20 percent to 30 percent as 
exporters expected the capital control to help weaken the baht. 
Further, importers hedging ratio have tended to be higher, 
suggesting exporters could hedge more.  According to the BOT 
researcher's presentation, importer's hedging ratio has been 20 -30 
percent since 2001 which increased to 30-35 percent in 2006 and 
early 2007. 
 
¶14.  (SBU) Hedging costs appear to be reasonable.  In a recent 
conversation, a private sector analyst approximated - depending on 
transaction size - hedging costs to be less than 1 percent of hedged 
exposure.  He also noted that his bank has seen a recent increase in 
exporters buying hedging products, but that many exporters do not 
fully hedge their foreign exchange exposure, preferring to take a 
position on currencies. 
 
 
Relax Constraints on Foreign Exchange Holding Period 
--------------------------------------------- 
 
¶15.  (SBU) The BOT maintains regulations on individual and company 
holdings of foreign currency. Individual and firms (which includes 
exporters) are allowed to hold up to $50,000 and $2 million, 
respectively, in foreign currency without showing proof that a 
foreign currency obligation is coming due in six months.  These 
limits have been raised incrementally, most recently in January, and 
may be raised again.  In late March, BOT's Financial Markets and 
Reserve Management Senior Director said the BOT is considering 
allowing exporters to hold foreign exchange longer than 15 days. 
However, again, some observers argue that a bold policy move - 
rather than an incremental one - could send a strong signal to 
markets that the BOT is aggressively pursuing a more market based 
solutions, and thereby improve investor sentiment. 
 
BOT Intervention Costly - Next Stop Moral Suasion 
--------------------------------------------- ---- 
 
¶16.  (SBU) Throughout this period, the BOT has been actively 
intervening in the currency markets and sterilizing - at increasing 
cost to its balance sheet - to stem baht appreciation.  Also, 
recently it returned to moral suasion, as noted in REFTEL 456, 
asking commercial banks to not take foreign exchange positions that 
were putting appreciation pressures on the baht.  Moral suasion, at 
best, is expected by local bankers to have only a short term effect. 
 
 
¶17.  (SBU) Over the past year, Thailand's foreign reserves have 
increased rapidly compared to other countries in the region.  The 
 
BANGKOK 00002392  004 OF 005 
 
 
BOT has not indicated its comfort level for reserves.  However, the 
BOT did recently note that international reserves are not high 
enough to establish a special investment entity similar to 
Singapore's GIC, thus suggesting that BOT may believe that reserves 
have not yet reached a critically high level.  Currently Thailand's 
foreign reserves are approximately $68 billion dollars (30 percent 
of GDP) and its net forward position $9.4 billion. 
 
¶18.  (SBU) In 2006, BOT's foreign reserves, as a percentage of its 
overall reserves, rose at one of the fastest rates in Asia - 28.7 
percent, behind India and China of 29.2 percent and 30.2 percent. 
As of March 23, combined reserves and net forward increased $5.4 
billion since the beginning of 2007, three times the amount by which 
reserves and net forwards increased ($1.8 billion) in the same 
period last year. 
 
¶19.  (SBU) Intervention and sterilization, however, is not costless 
for the BOT.  While the BOT enjoys a slight positive cost of carry 
on sterilization activities (as its return on foreign assets covers 
the interest cost on its sterilization), it suffered a large foreign 
reserve valuation loss in 2006, approximately $4.9 billion (2.4 
percent of GDP).  One informed analyst roughly estimated that BOT's 
foreign reserve composition is 60 percent USD and 20 percent each of 
EURO and the yen. 
 
¶20.  (SBU) Some observer's fear that losses to the central bank 
balance sheet could increase its susceptibility to political 
influence if it were to seek funding from the government for 
recapitalization.  As noted by BOT's Deputy Governor Atchana in 
early March in a meeting with FinAtt and EconOff, BOT's losses have 
become more politically sensitive as the MOF has been leaning more 
heavily on the BOT to pay off Financial Institution Development Fund 
(FIDF) bonds.  FIDF bonds (currently outstanding 232.2 billion baht) 
were floated in 2001 to re-capitalize banks following the Asian 
Financial Crises, with the agreement that the MOF would make 
interest payments and BOT would pay the principle.  The BOT thus far 
has paid off only a small portion of principle, with bonds rolled 
over, and the MOF continuing to make interest payments.  However, 
with the MOF looking to run a fiscal deficit for 2007 (and perhaps 
for a few more years thereafter), the MOF is pressuring the BOT to 
pay off FIDF principle so that the MOF can reduce its interest 
payments and free resources for other uses. 
 
Despite it All, Baht Remains Competitive 
---------------------------------------- 
 
¶21.  (SBU) The BOT, MOF, exporters, and local media have focused on 
the baht's 2006 nominal appreciation of 14 percent against the USD, 
greater than most other regional currencies.   However, a more 
medium term view of the baht's nominal effective exchange rate 
(NEER) and real effective exchange rate (REER), shows the baht 
moving more in line with regional currencies.  The IMF reported in 
its February Article IV Report on Thailand that the "medium-term 
appreciation of the baht is in line with other regional currencies 
and is not yet a major concern for competitiveness."  From 2004 to 
2006, the baht appreciated approximately 12 percent against the USD, 
third highest after the Philippines (13 percent) and Korea (28 
percent).  However it's NEER changed only 7 percent, more in line 
with other currencies (Malaysia 4 percent, Singapore 7 percent, 
Philippines 10 percent, Korea 26 percent).  A sense of the baht's 
"fundamental" value is difficult to gauge.  Two recent analyst 
reports stated opposing views on the baht: Credit Suisse noted a 
potential 20 percent under-valuation of the baht, Morgan Stanley a 
23 percent overvaluation against the USD. 
 
Benefits of Depreciated Baht Spread Out and Not Well-targeted 
--------------------------------------------- -- 
 
¶22.  (SBU) Not all exporters are affected by appreciation in the 
same way, but there is little public discussion of disaggregating 
exporters to identify those sectors hurt most by an appreciating 
baht and that would have the greatest impact on employment. 
According to a BOT researcher's presentation, most manufacturing 
firms enjoy a "natural hedge" (value of exports is relatively well 
balanced by value of imported content).  This holds across the 
spectrum of firm size. In other words, export firms with a large 
exposure to baht appreciation are not concentrated in small-size or 
large-sized firms.  An Executive Vice President of Kasikorn Bank 
(Boontuck Wungcharoen) was recently quoted in local press stating 
that his corporate customers in the import and export sector had not 
yet shown any negative effects from the stronger baht.  However, he 
 
BANGKOK 00002392  005 OF 005 
 
 
cautioned that impact from currency changes take about six months to 
show up in export/import figures. 
 
¶23.  (SBU) According to the BOT presentation, sectors with the 
greatest sensitivity to an appreciating baht include footwear, 
frozen shrimp and canned fruit and vegetables -clearly, those with 
the least amount of imported factors relative to overall production 
costs.  Sectors with the highest elasticity to exchange rate changes 
are agriculture and labor-intensive manufacturing, at 0.36 percent 
and 0.23 percent respectively (as a comparison, other elasticity 
measures are fishery at 0.05 percent, high tech manufacturing at 
0.07 percent and total exports at 0.10 percent.)  These sectors also 
are highly sensitive for employment: agriculture employs 38 percent 
of the labor force; labor intensive manufacturing employs 27 percent 
of the total labor in manufacturing.  This analysis is supported by 
a recent statement by Finance Minister Chalongphob who noted that 
multinational companies are doing well, but that labor intensive 
exporters are having a difficult time due to Vietnam and China 
catching up to all major competitors. 
 
¶24.  (SBU) However, it appears that the Federation of Thai 
Industries (the association representing Thailand's largest 
exporters) is dominating the debate, advocating for an depreciated 
baht in the name of all exporters.  The Secretary General of FTI was 
quoted in the local press in March stating that the FTI supports 
"any" measure to keep the baht depreciated.  There has been some 
public dissension.  Recently, FTI's Deputy Secretary-General Tanit 
Sorat, stated that the BOT should review capital controls and revoke 
if inappropriate, recognizing that the capital controls, by 
deteriorating investor confidence, has dragged down the economy as a 
whole.  The vice-chairman of the FTI told us that, because the 
association represents such a broad range of industries, arriving at 
a united position regarding baht appreciation has been difficult. 
The FTI chairman has instructed all members, if speaking for FTI, to 
follow the "baht should stay low" line. 
 
¶25.  (SBU) Comment: Exports, at more than 60 percent of GDP, will 
continue to create appreciation pressures so long as imports remain 
depressed.  Without an increase in domestic demand and imports, the 
BOT will be forced to heavily intervene if it wishes to keep the 
baht from appreciating at market-driven rates.  In the medium term, 
Thailand needs to shift its economy away from high export 
dependency, and more towards domestic consumption and investment. 
 
¶26.  (SBU) Finance Minister Chalongphob, as noted in reftel 1709, is 
working to increase imports to reduce appreciation pressures on the 
baht by pump priming the economy and restoring investor confidence. 
Governor Tarisa, however, appears out of touch, sticking to a line - 
"nab speculators" - when what is needed is a restoration of investor 
confidence.  Bold market-based measures could send a strong signal 
to markets.  Otherwise Thailand may be beaten out by other countries 
in the region that are apparently choosing more market-based 
solutions to address appreciation pressures on their currencies. 
 
¶27.  (SBU) Further, the benefits of a depreciated baht are not clear 
nor targeted.  The benefits are spread to all exporters, even those 
that may not be overly exposed to an appreciating baht and those 
that have low cost options to take on foreign exchange risk through 
purchase of hedged products.  The risk for Thailand is if the baht 
appreciates to a level that rice, rubber, tapioca, and cassava are 
no longer competitive on world markets, especially at a time when 
the rural sector is under some financial and political pressure from 
the end of Thaksin-era rural support program.  Unemployment is only 
1.2 percent but that is only because the agriculture sector acts as 
a giant sponge, soaking up workers when they have nothing else to 
do. 
 
¶28.  (SBU) In a meeting with FinAtt and Econoff in early March, 
Chalongphob noted that China's management of the Reminbi places 
pressures on its competitors, such as Thailand, to keep their 
currencies depreciated and less flexible.  Given the congruence of 
USG and ASEAN interests regarding currency flexibility (at least 
regarding China), bi-lateral meetings with ASEAN member countries 
during the Spring IMF/World Bank meeting could provide opportunities 
to start discussions towards cooperative efforts. 
 
Arvizu