Dealing with Capital Flows: Thailand in 2006

12 Pages Posted: 21 Oct 2008

See all articles by Wei Li

Wei Li

University of Virginia - Darden School of Business; Centre for Economic Policy Research (CEPR)

Abstract

This case was written as an exam case for first-year course, "Global Economies and Markets." It is written as a comprehensive case that examines the policy choices facing a small open economy in an increasingly globalizing world. It can be used in a course on open economy macroeconomics or on international finance. Late in the day on December 18, 2006, the Bank of Thailand (BOT), the country's central bank, announced that effective the next day it would impose a 30% unremunerated reserve requirement (URR) on short-term capital inflows. The capital control measure required financial institutions to withhold in reserve accounts 30% of capital inflows that exceeded USD 20,000 for a period of one year. The restriction on capital inflows represented a significant escalation of Thailand's battle to stop the appreciation of its official currency, the baht (THB). On December 19, the Stock Exchange of Thailand (SET) composite index dropped by a record 14.84%, wiping out THB800 billion or USD22 billion of market capitalization. The sell-off affected regional stock markets as well, with Jakarta (Indonesia) down 2.85%; Kuala Lumpur (Malaysia) down 2%; and Singapore down 2.23%. In the foreign exchange market, the baht lost 2% of its value against the U.S. dollar to settle at about THB36 to the dollar. The large foreign capital inflows and the resulting appreciation of the Thai baht had culminated in the decision by the interim government to impose capital controls. The dramatic reactions in the financial markets, however, had prompted Thai policymakers to reevaluate the situation and to consider policy options for 2007.

Excerpt

UVA-BP-0511

Dealing with capital flows: Thailand in 2006

Late in the day on December 18, 2006, the Bank of Thailand (BOT), the country's central bank, announced that effective from the next day it would impose a 30% unremunerated reserve requirement (URR) on short-term capital inflows. The capital control measure required financial institutions to withhold in reserve accounts 30% of capital inflows that exceeded USD20,000 for a period of one year. Inflows of funds related to international trade in goods and services or to repatriation of Thai residents' investment abroad were exempted from the URR. Foreign direct investment would initially be subject to the reserve requirement but would be refunded upon submission of supporting evidence and obtaining BOT approval. Because reserve accounts paid no interest, foreign investors would have to forego any expected returns on 30% of their investment in Thailand for one year. Under the URR, if a foreign investor allocated USD10 million to the Thai bond market, the investor could only buy USD7 million in Thai bonds and the remainder would be withheld at the BOT for one year, earning no interest. The investor would receive a full refund of the USD3 million withheld after the one-year holding period. If the investor requested a refund before the one-year holding period, the BOT would return only two-thirds of the USD3 million withheld.

. . .

Keywords: Capital controls, small open economy, Mundell's Impossible Trinity, International Finance, Exchange Rate Regime

Suggested Citation

Li, Wei, Dealing with Capital Flows: Thailand in 2006. Darden Case No. UVA-BP-0511. Available at SSRN: https://ssrn.com/abstract=1276570

Wei Li (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
804-243-7691 (Phone)
804-243-7681 (Fax)

HOME PAGE: http://www.darden.virginia.edu/faculty/li.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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