Hedging On Foreign Currency

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TREASURY VIEW

Hedging on foreign currency

By Nattawut Sachabudhawong

During the past couple of months, significant capital inflows have been anticipated here in Thailand. Those funds put a lot of pressure on the baht, which has strengthened against major currencies including the dollar. There are implications regarding the significant inflow, and many still lie ahead.

The baht traded at 32.3 per dollar on the last day of the second quarter. Meanwhile, our economic growth was robust during the first half, with more than 10 per cent growth during the first quarter, followed by another 7 per cent growth in the second quarter.

With strong momentum in export growth, a huge trade surplus of US$6.8 billion (Bt209 billion) was recorded during the first half of this year. The baht appreciated against the dollar by only 2 per cent during that same period.

However, with the political unrest ended, and with strong economic growth, Thailand has become a target for foreign investors. Capital inflows have come in, the stock index hit a new high since 1997, at 937 points, with the market cap exceeding Bt7 trillion for the first time. Huge capital inflow also means an increasing demand for the baht onshore, as investors need to sell dollars and convert them into baht before they buy any assets. This resulted in a sharp drop in the baht against dollar over the past two months, from 32.3 down to 30.7.

International reserves have increased by $10 billion to $160 billion. The Bank of Thailand has done quite a good job to curb capital inflows but not enough to keep the currency stable. In theory, the central bank can intervene in the exchange rate by buying foreign currencies and selling the baht, with more debt issuance to prevent excessive liquidity onshore. However, the reality is different. There are lots of stakeholders who participated in the flow: real investors who actually want to profit from capital gains, speculators who have no interest in local assets but want a free ride and to benefit from the currency gain, and traders who bet against currency volatility.

With all these participants, it becomes more difficult for any central bank to completely intervene to keep currencies stable. The aim of a central bank nowadays turns more to market stabilisation - in other words, if the currency comes under pressure from capital inflow, let it move in line with its peers at a gradual pace.

A rumour also surfaced over the past couple of weeks that the Bank of Thailand might consider a capital control measure to deal with any speculation in the baht. We do not believe this will be the smart choice. The baht appreciates on the back of good fundamentals, strong external balances in both the current account and capital account, and cheap pricing in both stocks and bonds. Using a capital control in this environment is not like giving investors a red card and a two-match ban as in football.

Using the wrong measure might trigger a fire sale across the markets. An equity market slump reflects the wealth of local investors and might soon reflect domestic demand. The bond market sell-off will lead to a higher long-dated interest rate which directly affects government and corporate spending via the need to pay more coupons on financing via debt issuances.

We believe that the Bank of Thailand will not introduce any capital control measure any time soon, as long as it can manage the currency volatility and let it move gradually. However, a relaxation of some regulations to allow onshore investors to buy more dollars, or a holding period for foreign currencies for exporters, might be the case.

But this approach might take time for the private sector to adapt to. With strong economic growth and capital flows into Southeast Asia, the baht will tend to get stronger and stronger against major currencies. Hedging FX risk is highly recommended during this period.

Nattawut Sachabudhawong is a member of the assets and liabilities management team of the Treasury Division at Siam Commercial Bank. The views expressed are the author's own.

-- The Nation 2010-09-22

[12DrinkMore]

This is a good article and should be widely read amongst the expats.

The THB, along with the other Asian currencies, is going to get stronger against the major western currencies, and, although there is always the speculative "front runners" coming in, it is based on fundamentals of Thailand/Asia producing stuff, with internal markets that can be developed and selling to external markets that do not produce the stuff they buy, and, in reality, have exported their jobs to Asia.