My 2 Cents:
How Strong Will the Baht Get?
   

          The Thai Baht suffered its largest one-day drop in 3 years by losing 1.3% against the US dollar on September 19 th when Prime Minister Thaksin was ousted by a military coup, which led international investors to wonder if they should brace themselves for another Asian contagion. Considering that Thailand has had 17 coups between 1932 and 1991, the concerns are understandable and should act as a wake-up call to political risk in other Asian nations. But given the sound macroeconomic fundamentals in the region, the latest uprising should not lead to another financial crisis. In fact the Thai Baht has recovered remarkably well since the coup two months ago and is now at a six years' high against the US dollar. How strong will the Baht get and what will this mean to your offshore investment?

          The strength of the Baht during the past two years must have caught everyone by surprise. Not only has it strengthened against the US dollar but also the other major currencies such as the Japanese Yen, the Euro and even the Singapore Dollar as well. So what gives? The answer may not lie with the Bank of Thailand but with the US Federal Reserve. The dollar is caught between a rock and a hard place and the Fed Chairman Ben Bernanke is running out of policy options. One the one hand, he is using inflation targeting to help him determine whether to change interest rates, but a growing portion of US inflation is now imported. Americans now import a staggering 13 million barrels of petroleum products a day, at an average cost of nearly $ 1 billion a day. The trade deficit is now running at an annualized rate of more than $ 776 billion or 6.2% of US GDP.

          Indeed, fighting inflation with higher interest rates may not work as well today as it did in the past, since rising rates now expose the increasing weakness of the dollar. Asian central banks collectively own $ 2.1 trillion of US debt, or more than 52% of the total. And higher rates are usually the Fed's compensation to holders of its debt. But if higher rates drive American consumers from the market place and foreign consumers do not pick up enough of the slack, central banks around the world may be forced to greatly reduce their dollar holdings. The dollar's dilemma is a dire one and there's no quick fix insight. Living beyond one's means is an addiction and it remains to be seen whether the Democrats dominated US Congress will have the resolve to rein spending and move towards a balanced budget, which the US enjoyed 8 years ago.

Source: Bank of Thailand (BOT)

          Given the strength of the Thai Baht in 2006, only the same could be said about the stock market. According to the Bank of Thailand (BOT), foreign investors have been net buyers of around Baht 113 billion in the Stock Exchange of Thailand (SET) during the first ten months of this year – up substantially from Baht 39 billion for full-year 2005. The SET started the month of November on a positive note but when one looks back at the 1-year return, the SET has a lot of catching up to do compared to other markets. (Please see Table below)

         What's most troubling about the current level of the Thai Baht vs other major currencies is that economic fundamentals do not really justify the Baht at this level. True enough, the Baht was boosted by foreign portfolio inflows and favourable interest rate differentials but it cannot be denied that much of the inflows are speculative “hot money”. For the first 11 months of the year the Thai Baht gained a whopping 11.66% against the US dollar making it one of the best performing Asian currencies in 2006. Moreover, the Baht also closed firmly up against most of the major currencies such as the Euro, the Japanese Yen as well as other regional currencies including the Singapore dollar, the Malaysian ringgit and the Chinese yuan.

          As part of the measures to cool down the speculative frenzy, the BOT announced in early November tighter controls on foreigners' purchases of certain debt instruments and derivatives contracts as well as banning the sale to nonresidents of bills of exchange of all maturities. It remains to be seen how successful these measures will be. Meanwhile, the sensible action to take is to diversify into non-traditional asset classes such as commodities and other currencies. Simply put, the Thai Baht can not go on rising forever nor can the USD for that matter. Diversification is not a compromise and will benefit us all in the long run.