THAI EQUITIES BOUNCE BUT PROBLEMS REMAIN

UNCLAS SECTION 01 OF 02 BANGKOK 007504 SIPDIS SENSITIVE SIPDIS STATE FOR EAP/MLS AND EB TREASURY FOR OASIA COMMERCE FOR EAP/MAC/OKSA STATE PASS TO FEDERAL RESERVE SAN FRANCSICO FOR DAN FINEMAN STATE PASS TO FEDERAL RESERVE NEW YORK FOR MATT HILDEBRANDT STATE PASS TO USTR FOR WEISEL E.O. 12958: N/A TAGS: EFIN ECON TH SUBJECT: THAI EQUITIES BOUNCE BUT PROBLEMS REMAIN REF: A. BANGKOK 7484 ¶B. BANGKOK 7435 ¶C. BANGKOK 6531 ¶D. BANGKOK 6156 BANGKOK 00007504 001.2 OF 002 ¶1. (SBU) On the evening of December 19, Deputy PM Pridiyathorn announced that his government would immediately lift the obligation for a non-interest bearing reserve requirement on foreign investors seeking to invest in Thai equities. The requirement would be maintained, however, on foreigners wishing to invest in Thai debt markets and real estate. Comment: By law, only the autonomous Bank of Thailand (BoT) is authorized to issue foreign exchange and capital control regulations. It took the BoT until midday December 20 to issue new regulations corresponding to Pridiyathorn's pronouncement. BoT Governor Tarisa is reportedly out of town on vacation. End Comment. ¶2. (U) In response to the news, the Thai Stock Exchange (SET) rose 10 percent at the open on December 20. Market observers tell us that the volume was moderate with retail investors especially looking to snap up bargains. Large foreign investors who failed to sell their positions yesterday were considering their next steps and apparently not heavy sellers today. There is considerable skepticism among market analysts here that the SET will be able to achieve the levels reached prior to the introduction of the new capital controls given the increased risk premium now associated with Thai markets. The baht was trading between 35.6 and 35.8 with an unusually wide spread between the bid and offer rates. Traders said that the reason for the volatility and wide spreads is because liquidity in the domestic market has been reduced in the wake of the new BoT regulations and far more trade is being conducted offshore. The head of the Public Debt Management Office called us to say that today's auction of 15-year treasury bonds resulted in a yield 50-60 basis points above last week's auction. He expects the result of the BoT regulations to be "a substantial increase in funding costs" for the RTG. ¶3. (SBU) Commerce Permanent Secretary Karun told us that he had consulted with the BoT before they made their initial decision on imposing capital controls. Their analysis was that the RTG had to take some drastic action because Thai exporter's margins were being so severely squeezed by the appreciating baht and capital inflows were increasing from an average of US$300 million/week to US$950 million last week. After "informal" consultations with the IMF, the RTG determined that lowering interest rates as a remedy would be "ineffective" in the face of the large funds inflow and they were afraid that a real crisis would occur in the export sector--the only sector in the Thai economy that has been performing well this year. Karun said that the reaction of the SET was "beyond expectations" but also argued that everyone needed to look at the situation over the longer term; that if the baht had continued to strengthen to 34/US$ "the situation would be even worse." ¶4. (SBU) We spoke to BoT Assistant Governor for Financial Market Operations, Nitaya Pibulrantanagit, and asked about how the latest set of regulations would work i.e. how the commercial banks that receive f/x inflows could be sure that the funds actually went to the SET (and not debt markets or property) and therefore were exempt from the 30 percent requirement. She replied that all funds received and identified for SET investments would be placed in a non-resident account at the BoT which could then be drawn on only for settlement of SET transactions. Bankers with whom we spoke are very concerned about the manual nature of tracking these flows and the associated high costs. ¶5. (SBU) We also asked Nitaya about the reported unusually high capital inflows and whether they had been analyzed as to whether they were the result of speculators, exporters converting their US$ earnings or other factors. We had earlier learned that a major telecom company here at earlier this month repatriated $450 million from an (fully hedged) BANGKOK 00007504 002.2 OF 002 offshore bond issuance Nitaya advised that the BoT had not done an analysis of the inflows and that the referred-to US$950 million was a "gross number using raw data." One banker argued that if the inflows into money market instruments were as heavy as the BoT implies then "effective short-term interest rates would be about zero" because of the relative lack of available debt instruments. ¶6. (SBU) Comment: The 1997 crisis was the defining moment for most Thais involved in the financial sector, including Pridiyathorn. He took several lessons away from that event; a) foreigners are short-term oriented and do not have Thai interests at heart, b) the mistake the Thais made in 1997 was not enacting and enforcing tough regulations and causing financial pain to the foreign speculators who were behind all the trouble. Given this general view, it is perhaps unsurprising that the solution to the current problem would be a dramatic move intended to flush out the speculators from their positions. Unfortunately, this reveals a basic distrust of the efficiency of markets and a failure to properly analyze and address the reasons behind the appreciating baht (see reftels). Many observers believe that it also displays a high degree of both arrogance (for not consulting with actual market experts as to the likely fallout) and ignorance (for not understanding the likely result himself). ¶7. (SBU) Comment continued: These observers also believe that the usually cautious Pridiyathorn moved precipitously to impose capital controls because he was threatened with being replaced as a sop to exporters. (This might explain his flip-flop from last week when he said that exporters would simply have to get used to a strong baht for the next year.) That would seriously threaten Pridiyathorn's (widely presumed) ambition to become the next prime minister. The events of the past 48 hours have not advanced his political ambitions, although the extent of the damage remains to be seen. BoT Governor Tarisa is also under severe scrutiny and, if she is in fact at play while the markets burn, she may not remain in her position for long. ARVIZU