Baht Were They Thinking!?

Since the coup earlier this year (see our past commentary: "Could a Thai Coup Overthrow the Markets?"), Thailand's new military-installed government has made a major economic policy gaffe. Effectively a hefty tax on foreign investors, Thailand instituted a new policy to slow the rapid appreciation of its currency (the baht) to support the country's exporters. But the experiment went horribly wrong and the Thai markets closed over 15% lower for the day. Baht were they thinking!? Here are the facts:

• Yesterday, Thailand's regulators said they will require banks to lock up 30% of new foreign exchange deposits for a year to curb currency speculation
• Under the controls, overseas investors buying the baht currency would only be able to invest 70% of what they transfer, and only recoup all of their funds if they keep the money in Thailand for more than a year
• Those who withdraw the reserved amount in less than a year will be penalized 33% of that 30% portion
• The rule applies to transactions worth more than $20,000
• The 30% locked up won't earn any interest
• The rule exempts currency transactions related to trade in goods and services, or repatriation of investments abroad by residents
• Thailand's SET stock Index fell 15% on the news. The Thai Baht fell 1.6%
• Following the decline in the stock market, the Thai government said it would lift controls on foreign investment in stocks
• The controls will remain on foreign investments in bonds and commercial paper as part of central bank's measures to stem the surge of speculative investment in the baht
• The sell off in the Thai stock market was the biggest since the Asian financial crisis of 1997

The worry is that these events will lead to a "contagion" similar to the 1997 Asian Financial Crisis. That's a long shot. The current economic expansion and equities bull market in Asia rests on a number of positive factors vastly outweighing this small event.

Central banks in Malaysia and the Philippines have already stated they have no plans to follow Thailand's lead. Besides, the events leading to the Asian Financial crisis were very different: back then most Asian countries were facing weakening currencies, not stronger ones. And as a region, Asia is much more economically healthy and stable today.

This appears to be an isolated event, not a symptom of a pervasive policy mistake by many nations. And anyway, the Thai policy restricting equity investment only lived about a day—all that's left are restrictions on bonds and commercial paper. Also, consider that Thailand represents only 0.13% of the MSCI All Country World Index by market capitalization.

So, it's just not a very big event in broad economic or market terms. But it is a very big mistake for a fledgling government trying to gain legitimacy. These events, in conjunction with September's coup, aren't likely to instill much confidence in the Thai market going forward.

So, baht the heck were they thinking? It's another example of unnecessary government intervention into a market-based system. The Thai government tried to strengthen its currency and help its exporters through regulation. As we've seen many times before, markets abhor such practices because they create inefficiency, additional costs, and barriers to the free flow of capital.