Introduction
To implement financial or monetary policy, the Central Bank can directly use its regulatory authority or utilise its indirectly influence on the money market circumstances as the reserve currency issuer (money in flow and placed balances) with the Central Bank (Alexander, Balino, and Enoch, 1996), where the indirect instruments operate through the market by amending the primary demand and supply of the bank reserve (Alexander et al, 1996).
The Unremunerated Reserve Requirement (URR) is a need to cling to an unremunerated preset term reserve at the Bank of Thailand for one year which is equal to a proportion of resources inflows in definite groups and therefore, the URR is equivalent to tax per element time that reduces with maturity of influenced resource inflow (Asianbondsonline.adb.org, 2010).
Motivation behind URR
Thailand economy has contained its economic integration with other markets in the world within the last decade and this has fetched advantages in form of superior diversification and low capital cost, however, it brings superior risks coupled with improved volatility of surge that eventually result to superior distribution of portfolio inflows (Thaicharoen and Ananchotikul, 2008).
The flow of capital inflows, associated with surplus in the current account, placed a hard to believe strain on the Thai baht, resulting in extreme Thai baht appreciation (Thaicharoen and Ananchotikul, 2008). If left unattended, this may possibly have endangered performance of the export and, more significantly, instability in the Thai economy as demand was blemished by political insecurities and in a denial circumstance to provide an optional growth engine. Consequently, the Bank of Thailand (BOT) made a decision to intervene in holding back the unwarranted baht appreciation. Nevertheless, various traditional techniques of managing the rate of exchange confirmed to be unproductive as the swiftness of currency appreciation accelerated persistently (Thaicharoen and Ananchotikul, 2008).
The URR was therefore put into practice at the end of the year 2006 to deliver a price-based resistance but opted for short-range capital inflows, with an intention of dawdling down the speed of currency appreciation, sinking short-range capital inflows as well as permitting the economy to swindle with huge variations in the global prices (Thaicharoen and Ananchotikul, 2008). The facts recommended that, this technique had done well in attaining its set objectives, as the capital inflows had been abridged, the currency was stable and Thai economy went on expanding, adequately with vigorous export performance with symptom of upturn in home demand (Thaicharoen and Ananchotikul, 2008).
Aware of harmful and deformational consequences of URR gauge, particularly if left in-position for a long time, the BOT later removed this policy in March 2008, after warranting that the risk of unnecessary baht movements had caved in plus that the economy of Thai had recovered and was set to handle possible flow and baht volatility (Thaicharoen and Ananchotikul, 2008).
Impact of URR provision on the Exchange rate of Thai with other major currencies such as US$ and local currencies
Capital inflows lead to Thai baht appreciations built up in 2006 as a result enormous overseas capitals flowed to Thai to earn higher returns. The Thai bonds return was 6% in 2006, plus 17% from baht appreciation starting from 2006, in total investors earned 23% as return (Bot.or.th, 2008). In a period of three months, about 100,000 million or $ 3,000 million of overseas capital flowed into Thai to put in the short-term investments and speculate on Thai baht appreciation and at the end of the year 2006, $ 1,000 million flowed to Thai in a day, to improve excess exchange rate variations, the BOT enforced restrictions on the short-range speculative inflows at the same time, relaxed capital outflows regulation (Bot.or.th, 2008).
This policy aimed at enhancing the supply of Thai baht to go with the rising demand for Thai baht and as a result the strain on Thai baht, appreciation was reduced, however, baht continued to appreciate and on December the Baht/USD exchange rate was at 35.09 baht to one US dollar, on top of smashing the psychological intensity (Bot.or.th, 2008). The URR was put in place on 18th December, 2006 and the baht destabilized to 35.90 baht to the United States dollar on 19th following the implementation; Nevertheless, the instability of Baht/USD exchange rate rose with Baht varying from 35.83 to 39.62 Baht to the USD, the broadest variation in all periods (Bot.or.th, 2008). In addition to this, URR provision also helped the Thai baht to move in line with the region currencies such as the Philippines PHP, Indonesia INDO, Singapore SGD, Korea KRW and Taiwan TWD (Bot.or.th, 2008).
This trend continued persistently in 2007 but eventually, the variation became modest, on December 2007 and Thai baht was at 33.70 to the USD, with this was an appreciation of 5.94% compared to December 2006; URR was eliminated on March 2008 and the Baht/USD rate of exchange was at 31.46 baht to one USD (Bot.or.th, 2008).
Impact of URR on Thai financial markets
The stock market responded negatively to the gauge as the URR was observed by severe market trends which resulted to sinking of the Stock Exchange of Thailand (SET) on the first day of putting in practice capital control and also the market capitalisation reduced by 800,000 million baht (Bot.or.th, 2008). To fight this panic, the stock market trading transaction was precisely delayed for about 30 minutes. Nonetheless, the Stock Exchange of Thailand index dropped by 100.37 to 630.18 points following the recommencement of trading in the SET, it further dropped by about 20% to that day’s drain at 587.92 points, before bouncing back a little to close the day at 622.14 points (Bot.or.th, 2008); the index dropped by 14.84% at the finish of the trading day, the largest fall in one trading day, making history in the last 31 years of the SET (Bot.or.th, 2008).
On 19th December 2006, the central bank declared modification to the policy on the requirements of a reserve by removing the control forced on the stock investments and this amendment received an optimistic feedback from the overseas investors resulting to a general increase in the market capitalisation by 500 billion Thai Baht to 5,161,613.16 million Baht and the SET index raised by about 60 points. Nevertheless, the reserve necessities on the short-range capital flows are presently in use in the bond market (Bot.or.th, 2008).
Impact of URR provision on neighbouring financial market
The increase in reserve and excess liquidity initialising from interference, created an extra major ruling challenged the forming of liquidity management and the BOT generally sterilised to counterbalance the surplus liquidity, following from foreign exchange interference with the intention of avoiding inflationary outcome and upholding the rate of policy at the intensity put by Monetary Policy committee (Bot.or.th, 2008).
The central bank can raise reserves requirements or use the open market procedures by use of sterilisation; reserve requirements inflict cost charges on the financial institutions on conditions that reserve requirements are remunerated or unremunerated at lower charges than the market rate; the open market was chosen for sterilisation, mainly through the issuance of FX swap, repurchase transactions and BOT bonds (Bot.or.th, 2008).
The URR provision in Thailand produced a Two-tier Foreign exchange market, wherein the Baht was less cheap in onshore market and costly in the offshore market. However, all foreign exchange transactions relating to Baht were resolved onshore, the difference in the foreign exchange rate occasionally produced confusion amongst the exporters and this led to fear trading of the United States dollar, particularly throughout the early stage following the implementation of the URR (Bot.or.th, 2008). Furthermore, a few market contributors were worried that foreign exchange rate might act as an investors’ emotional reference point which could result to a satisfactory prediction, where the foreign exchange baht rate was likely to fluctuate in the direction of the more costly offshore rate (Bot.or.th, 2008).
Conclusion
The implementation of capital controls for example, URR gauge might be a policy alternative in some circumstances, but cautiously ought to be paid to strict performance plans to reduce the possibility of unfavourable outcome on the microeconomic costs and markets. It is very important to understand that the BOT ability to run the exchange rate and fluctuations of capital flows are fairly limited, particularly alongside the setting of improved integration of the international financial markets; the main concern should be to put into practice reforms that determine the strength of the economy elasticity alongside currency variations and flows.
Reference
Alexander, W. Balino, T. and Enoch, C. (1996). Adopting indirect instruments of monetary policy. Web.
Asianbondsonline.adb.org. (2010). Investment management. Web.
Bot.or.th (2008). Lifting of the requirement on Short-term capital inflows. Web.
Thaicharoen, Y. and Ananchotikul, N. (2008). Thailand’s experiences with rising capital flows: recent challenges and policy responses. Web.