THAILAND TO LIFT 30-PERCENT RESERVE REQUIREMENT

C O N F I D E N T I A L SECTION 01 OF 02 BANGKOK 000469

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STATE FOR EAP/MLS AND EB
STATE PASS TO USTR
TREASURY FOR OASIA
COMMERCE FOR EAP/MAC/OKSA

E.O. 12958: DECL: 02/12/2018
TAGS: EFIN EINV ECON ETRD TH
SUBJECT: THAILAND TO LIFT 30-PERCENT RESERVE REQUIREMENT
THIS YEAR

REF: BANGKOK 430 AND PREVIOUS

Classified By: Economic Counselor Robert D. Griffiths for Reason 1.4 (b
) and (d)


1. (U) New Finance Minister Surapong Suebwonglee said
February 12 that no decision had yet been made to immediately
remove the 30 percent unremunerated reserve requirement (URR)
after his two-hour meeting with Bank of Thailand (BOT)
Governor Tarisa Watanagase. Surapong, also the PPP party's
Secretary General, had said during the recent general

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election campaign that abolishing the URR would be a top
priority of a PPP-led government "to send a powerful signal
to foreign investors" that Thailand would redouble its
efforts to attract foreign investment. However, since the
new government's installation, senior BOT officials,
including the Governor and her top aides, have urged the
Finance Ministry to take a cautious approach to lifting the
requirement. While a decision to remove the URR is
considered inevitable this year, the BOT has expressed
concern that a quick repeal of the controls would spur a
sharp influx of foreign capital, adding to pressure for the
Thai currency to appreciate. Thai exporter associations have
also warned that they foresee a short-term 10 percent
appreciation of the baht if the URR is removed.


2. (U) Surapong said the government would make a decision on
the URR before embarking a planned international investment
roadshow in late March and early April. "A clear-cut policy
on the URR and the exchange rate should be finalized before I
make a roadshow trip overseas," he said. "I would like to
make sure I understand the situation completely," he said.
He added, however, that "the central bank has to make its own
decision on the 30 percent reserve requirement," and would
make its decision after consultation with Surapong's Ministry.

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THE URR - WHAT IS IT?
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3. (U) When it was introduced on December 18, 2006, the 30
percent unremunerated reserve requirement (URR) applied to
all short-term capital inflows (less than one year duration).
The URR required all foreign capital inflows above USD
20,000 to have 30 percent of the principal amount deposited
with the Bank of Thailand for one year in a non-interest
bearing account. The BOT argued that the URR was a temporary
necessity to regulate "hot-money" flowing into Thai
investment instruments from speculators betting that the baht
would continue to appreciate. After a dramatic 15 percent
drop in the Thai stock market index the day after the URR was
announced, the Finance Ministry partially reversed the
decision, repealing the URR requirement for any investment in
Thai equities.


4. (U) Since that about-face, the BOT has gradually removed
the URR measure in other areas, such as real estate and
property funds, to the point where it currently only applies
to foreign investment in bonds (government and private),
mutual funds, and foreign currency borrowing. Investors also
have the option of avoiding the 30 percent URR entirely if
they fully hedge their investments for currency risk. They
can do this by arranging a currency swap agreement with a
Thai commercial bank (by selling the bank foreign currency
with an agreement to buy back the full amount of the currency
at a future date). According to BOT officials, most
investors have opted for this fully-hedged requirement rather
than go through the 30 percent URR process.

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URR FAILED TO IMPACT EXCHANGE RATE
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5. (C) Financial analysts do not believe that the intended
impact of the URR, to slow the appreciation of the Thai baht,
has been realized as the baht has risen 8 percent since the
URR's enactment just over a year ago. While it could be
argued that the baht would have risen more without the
controls, the URR contributed to a decline in overall
investor sentiment in Thailand, perhaps exacerbating the flat

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domestic investment (and import demand) conditions that made
the current account surplus so unusually large. Furthermore,
the URR created a two-tier market for the Thai currency, with
the offshore baht price generally higher by 1.5 to 2 baht
than the onshore rate (although that gap has narrowed with
anticipation that the URR might be ended). In the words of
Kasikorn Bank senior researcher Kobsidth Silpachai, the
higher offshore rate created "a psychological reference
point" for the baht's future direction, and made the baht's
strengthening a self-fulfilling prophecy.


6. (C) In another view, former Finance Minister Chalongphon
Sussangkarn, who stepped down when the current cabinet was
inaugurated, told econoffs on February 12 that the URR
carries mostly symbolic weight apart from the bond market,
where its influence remains for instruments of less than one
year's duration. "Because the initial controls were later
watered-down, and with most investors opting to hedge their
investments, there aren't currently very many inflows subject
to the URR," he said. Chalongphob said the U.S. dollar's
weakness was the primary driving force of the baht's
appreciation over the past two years. A continual weakening
of the dollar would make it all the more difficult for the
BOT to prop up the baht in the long term, he added.

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LIKELY OUTCOME - THE LATTER HALF OF 2008?
--------------


7. (U) While some market participants are optimistic about an
immediate repeal of the URR (and the stock market has risen
strongly this week on such anticipation),analysts are split
on whether it will occur before Spring or in the second half
of 2008. Factors weighing against removing the URR at this
time include the recent sharp drop in U.S. interest rates,
which makes Thailand more susceptible to capital inflows due
to the relatively higher Thai rate, and the strong current
account surplus which continues to place upward pressure on
the baht. Analysts from Kasikorn Bank, Thailand's
second-largest private bank, predict that conditions to
repeal the URR will ease in the second and third quarters of
the year, when a drop in export growth is expected with the
global economic slowdown, and the BOT has further reduced
Thai interest rates. Analysts from Standard Chartered Bank
have given a 60 percent chance that the controls will be
lifted in the last three quarters of 2008 (calendar year),
and a 40 percent chance that they would be lifted before then.


8. (C) Comment: Regardless of the ultimate economic impact of
the decision, one thing seems clear: If the new Finance
Minister succeeds in overturning the URR measure prior to his
investment roadshow in March, it will be done over the
objections of the BOT and signal the Finance Ministry's
willingness to challenge BOT policy if it interferes with the
new government's pro-growth policies. Such a move would give
Surapong heightened stature among those who have questioned
his influence.
JOHN