The idea of establishing a central bank in Thailand came about during the reign of King Rama IV after the 1932 uprising. The idea was proposed by the Economic Plan People’s Party (EPPP). They felt that there was need to establish a central bank to provide mechanisms for pursuing economic policies for Siam. This did not happen immediately as it needed time.
The central bank of Thailand, also known as the Bank of Thailand (BOT), was first set up as Thai National Banking Bureau (TNBB) on 13th May 1940. A year later, Japanese troops invaded Thailand during the second world war and demanded that a central bank of Thailand be established and to be comprised of Japanese officials. The Thai government drafted a bill that changed the TNBB to a central bank. On April 16th 1942 the bank of Thailand act was passed which gave power to the bank of Thailand to take all the responsibilities of central banking in Thailand. The bank began its operations as a central bank on 10th December 1942.
The act was later amended to give the bank more responsibilities, institute decision mechanisms as well as putting into place mechanisms to guard against economic crisis. These amendments came into full effect on 4th March 2008.
The case; what happened
The Central Bank of Thailand (BOT) gave regulations on capital reserves on December 18, 2006. This decision is believed to have been motivated by the fact that during the same year, the exchange rate of the Thai Baht against the US dollar and other currencies had appreciated by more than 15 %. These developments in the foreign exchange market made exports from Thailand to be less competitive in the global market. These regulations were to apply to payments in form of foreign currencies for various transactions (Stephen, F., 2007, para 1).
The issued regulations required that the Thai banks and other financial institutions withhold 30% of the amount of foreign currency they get. The currency also had to be in terms of the Thai Baht. The regulations also required the reserves to be deposited with the central bank for a period of one year during which no interest would be earned on the amount. However banks and other institutions of finance intending to request for the money before the end of the one year could do so, but in such cases, only a third of the whole amount could be availed. The regulations were followed by protest from both the Thai citizens and foreign investors, numerous revisions have been done on the regulations up to date.
Motivation behind the case
As stated earlier the issue of regulation was believed to be as a result of increase in the exchange rates of the Thai Baht. As Tongurai & Vithessonthi explain (2008, para 2), exchange stability, domestic monetary independence and financial integration are economic goals that cannot go along well. The three goals cannot be achieved at the same time altogether. A country must be able to leave one in favor of the others. The Thai government could not leave the goal of exchange rate stability and monetary independence and due to this fact it chose to issue the regulations in order to safeguard these two goals (Tongurai & Vithessonthi, 2008). During the second half of the year 2006, an increase in the amount of capital inflow was noted. This motivated the monetary authorities to act so as to curb the effects which could have followed.
Impacts of the regulation on exchange rate of Thai Baht with other major currencies
According to Tongurai & Vithessonthi, in most cases capital control measures on capital inflow are taken so as to prevent speculative capital that has the capability of influencing increases in the rate of exchange. It is worth noting that prior to the introduction of the regulations the Thai monetary authorities has speculated on the currency. There had been observed massive increase in foreign capital inflow a few months before the regulations were introduced (Tongurai & Vithessonthi, 2008). The regulations were seen to target speculative capital inflows in the near future with an aim of stabilizing foreign exchange rate as well as the Thai economy. The impacts of this regulation were meant to be increases in the interest rates. The Thai government could not just watch the domestic interest rates fall. They had to act, and this called for the regulations. They had to weaken the Baht and limit speculations on currency exchange. If the capital inflow was left to increase it would have caused major effects such as inflation
Impact of URR on Thai financial markets
The regulation issued by the Thai monetary authorities had an immediate effect on the financial market. This is usually by affecting the asset prices and returns according to Tongurai & Vithessonthi (2008). After the regulations it is reported that the Thai stock exchange fell by 16 %. These regulations affected mostly those frequent traders who trade in Thai securities as speculators. It however did not affect as much those traders who bought securities for a long term investment. The regulation was indeed aimed to tame short term speculators. The regulation however had diverse effects as it saw market capitalization fall by close to 800 million in baht currency. This saw the suspension of operations at the stock exchange for about 30 minutes. Further reductions resulted in terms of SET index. Due to anxiety from the foreign investors on the developments in the stock market, there was reported a significant reduction in investments held by foreign investors. This prompted the government and the monetary authorities to revise the regulations to curb negative effects on the economy. Economically if a government decides to put regulation on capital or rather introduce capital controls, this may reduce foreign investment as it increases risks faced by the foreign investors. The possible effects of such regulations as those issued by bank of Thailand is that, due to foreign investors shying off the domestic foreign markets will become more volatile. The demand for short term bank loans would increase due to the shortage of capital. This justifies the volatility of the financial markets. The price of assets such as securities and real estates would reduce if capital inflows are reduced. This is exactly what happened in Thailand. As stated earlier prior to the issuance of the regulations the monetary authorities had observed speculations. This led to booms in the price of assets. The capital control regulations were therefore meant to curb these increases to maintain stability in the exchange rates.
Impact of URR on neighboring financial markets
Contagion is a situation where the financial crisis in a country tends to spread to other countries especially the trading partners and the neighboring countries. This phenomenon was also experienced as a result of the Thailand capital inflow regulations. The regulations reduced the volatility of the Malaysian financial markets especially the banking sector. This was attributed to the fact that most Malaysian investors who wanted to commit some investments in Thailand feared that diverse repercussions could befall them in Thailand following the issuance of the regulations. Most of these investors and also those from other neighboring countries reduced their bank borrowing. This was the main cause of reduced volatility in these countries (Adams, F., 1998, pg. 45).
However from an economic point of view these regulations could still mean increased activities in other financial markets especially the stock markets and the bonds market (Garcia & Edwards, 2008, pg. 152). The argument is that if the foreign investors avoid investing in this country, then it means that their disposable income will have increased and this increases the marginal propensity to invest. The resulting effects are that domestic investments in securities and bonds will increase. This therefore increases the activities and the operations of the domestic stock markets as well as the bonds market.
Due to the diverse effects which followed and which the monetary authorities in Thailand never expected the regulations were largely revised amid consistent protest from foreign investors and local investors as well.
Capital inflow on financial markets
Adams, F., 1998. International capital markets: developments prospects and key policy issues. New York: IMF
Garcia, M. & Edwards, S., 2008. Financial markets volatility and performance in emerging markets. [E-book] Chicago: University Of Chicago Press.
Stephen, F. Protecting the Baht – Capital reserves requirements in Thailand 2007. Bangkok international associates. Web.
Vithessonthi, C., & Tongurai, J., 2008.The effects of capital control on stock prices. Journal of International Business & Economic. 2 (8), Web.