Thailand cuts rates to undermine baht; what’s next – capital controls? Asia might find itself in the grip of a cycle where further cuts and controls are the only way to maintain competitiveness

Thailand cuts rates to undermine baht; what’s next – capital controls?

May 29, 2013 2:18pm by Jake Maxwell Watts

Thailand became the latest of several Asian countries to actively encourage the depreciation of its currency on Wednesday, continuing a trend that is likely to leave other regional economies with little choice but to follow.

Its central bank cut interest rates by 25 basis points from 2.75 per cent to 2.5 per cent a year, in an attempt to stem a rise in the baht, which hit a 16-year high last month. The Thai finance ministry is considering adding capital controls to the mix.

The rate cut is unlikely to do enough to resolve a long-standing dispute between the central bank’s governor, Prasarn Trairatvorakul, and Thailand’s finance minister Kittirat Na Ranong about whether a cut is the best way to discourage foreign capital inflows.Kittiratt has argued for at least a 0.5 per cent rate cut, pointing to flagging exports, which have become more expensive with the stronger baht. Indeed, last week Thailand lowered its 2013 forecast for export growth from 11 per cent to 7.6 per cent.

But Prasarn has been reluctant to lower interest rates further since the bank’s last cut in October, arguing that low rates would trigger a rise in inflation and make an asset bubble more likely. The IMF has already warned that asset bubbles are a risk, reversing its historical position in December when it endorsed the use of capital controls.

Prasarn’s position raises the probability that the finance ministry will go ahead with one or more of the proposals outlined by the central bank in April, which included setting levies and fees on capital gains made by foreign bond holders and setting minimum holding periods on foreign purchases.

Frederic Neumann, chief Asian economist at HSBC, told the FT last month that “capital controls are back on the table”, particularly as Japan’s economic policies have raised expectations that a rush of Japanese money will arrive in Asia, pushing up the baht further. “The train has already left Tokyo station,” he said. Its arrival was only a matter of time.

Whether or not the Thai government decides to implement controls, the central bank’s rate cut is likely to have regional repercussions. “Abenomics” in Japan includes measures to devalue the yen, with a knock on effect on South Korean exporters, who have struggled to compete with cheap Japanese goods prompting their own central bank to cut interest rates. Australia has done the same.

So who is next? The Philippines, for example, has been fighting a housing bubble with interest rate adjustments and limits on property loans, and has not completely ruled out turning to capital controls in the future. It isn’t alone. Asian corporate bond markets have almost doubled in size since the end of 2008 and foreign ownership of government bonds in the Philippines, Malaysia and Indonesia has soared.

Even if Thailand goes ahead with capital controls, there’s no guarantee that they will work. The kingdom’s last attempts in 2010 and 2006 barely affected the baht at all. But if the baht depreciates as the central bank intends, Asia might find itself in the grip of a cycle where further cuts and controls are the only way to maintain competitiveness.