The Thai baht is freely floated, preventing price and value distortion from building up.
Currency movements can affect your investment returns. In this issue, we examine the performance of the Thai baht versus the Singapore dollar.
By Paul Ho
Buying a property overseas is a major decision. What are the things you have to know before committing to a purchase? There are three major considerations for overseas property investment, namely potential capital gains, investment yields and loan servicing ability.
From our observation, people who have made money in property do so more from property investment capital gains, and less so from the yield via renting the property out.
Currency effects on property investments in Thailand
When you invest in a Thai property, you have to pay in Thai baht. But how do you calculate your gains or losses?
For example, someone who uses Singapore dollars as a base currency and buys a property in Thailand will have to exchange Singapore dollars for Thai baht.
Buy: at THB4,800,000 at (S$1: THB24), that is S$200,000.
Sell: at THB6,000,000 at (S$1: THB35), that is S$171,429.
In baht, you made THB1,200,000, but in Singapore dollar, you would have lost S$28,571.
If you have relocated to Thailand and your daily needs are funded in baht, then you are fine as long as the baht’s purchasing power is not significantly diminished against other major currencies or trading partners of Thailand, or else you would have lost purchasing power when it comes to buying products outside of Thailand.
However, if your lifestyle centres around your base currency, and it is in Singapore dollars, then you will need to measure your capital gains or losses in your base currency.
Asset diversification and portfolio management
If you are investing for asset diversification to maintain the overall value of your assets from wild fluctuations, then you should not mind short-term currency movements as one currency’s depreciation is often offset by the rise in other currencies.
What do monetary authorities and central banks control?
These central banks and monetary authorities generally control or watch the following: –
• Currency exchange rate
• Capital inflow / outflow control
• Interest rate
Most governments can only select one or two to control, but not all three. This is the dilemma when it comes to monetary policy, where governments cannot control all three aspects.
For example, if country A has a five percent interest rate, then country B will want to force its only interest rate to two percent.
If the capital is free to move, then country B loses capital to country A, because country B pays better interest.
If exchange rates are free to move (unpegged), then country B’s currency loses value, while country A’s currency gains value.
This is how a country’s monetary policy and growth rate can affect its currency value. If a country sets its currency at a certain level that is not supported by the market, there will be a gap between the actual value and real value. Speculators will come in and take a profit.
What happened to Thailand during the Asian Financial Crisis?
What happens when a country fixes its exchange rate? When it does this, and adopts free capital flow, it loses its monetary sovereignty of setting interest rates, money supply, etc.
When Thailand’s economy slowed down and the kingdom needed to lower interest rates to stimulate its economy, foreign funds which invested in Thailand decided to pull out in search of better returns, also known as capital outflows. When capital pulls out, they are typically pulled from the share market, property market and loans (which are lent to Thai businesses). This caused a severe shock to Thai businesses as funds became scarce. Businesses dependent on foreign lending started to suffer, as their access to capital became restricted.
As funds left Thailand, interest rates began to rise. The Thai government needed to use reserves to prop up the Thai baht by selling USD to buy baht, supporting its value. This used up large amounts of foreign reserves (typically US dollars) that were pitted against hedge funds, which ended up gifting the hedge funds tens of billions of dollars in a hopeless defense of the Thai baht, which saw it devalue in a managed fl oat of its currency peg to ease the defense of the currency using foreign reserves. When the Thai baht depreciated, more Thai businesses went bankrupt as they held large debt, which were in US dollars.
This meant that the US dollar was becoming more expensive to service while they earned in Thai baht, which consequently dropped in value, coupled with the softening economy, which made earning a depreciating baht even tougher.
What is different in Thailand today?
As a result of learning from the painful experience of pegging the exchange rate in 1997, the exchange rate is now allowed to float freely. This prevents price and value distortion from building up.
For instance, if the exchange rate is S$1:26, but the perceived fair value is S$1:35, then speculators will be selling Thai assets and using 26 baht to S$1 to exit Thai baht in exchange for Singapore dollars. If they don’t do so, when fair market value prevails, they will be using 35 baht for one Singapore dollar.
When the baht is freely floated, there is little price distortion, as the traded exchange rate reflects the market value more closely.
Thailand’s debt-to-GDP ratio is below 50 percent, nowhere near dangerous. The kingdom’s foreign reserves can more than pay off its government’s external debt if it wants to as it has US$160 billion in reserves, while approximately US$130 billion in external debt.
At present, Thailand’s foreign reserves are one of Asia’s largest at around US$160 billion.
The Thai government has a strong foreign exchange reserve position, which is one of the highest among developing economies. And it is continuing to run a trade surplus, accumulating foreign exchange reserves.
Due to the free fl oat of currency exchange, it is able to set its own interest rate more effectively. At a time when the Thai economy is starting to see signs of a slowdown, and the US economy and US dollar are showing signs of strength, instead of raising the interest rate to prevent funds outflow and maintain the exchange rate, it surprisingly lowered and kept interest rates at 1.5 percent to continue to keep borrowing costs low for Thai businesses. Doing so weakens the Thai baht and creates some capital outflow, which Thailand is able to withstand while it stimulates the economy and further increases export competitiveness.
Thai baht versus Singapore dollar
According to the MAS, Singapore manages its Singapore dollar nominal effective exchange rate (S$NEER) against a trade-weighted basket of 15 currencies of its major trading partners. As Singapore is trade dependent, with trade accounting for about 200 percent of its GDP, therefore Singapore regulates its exchange rate to control import inflation.
Hence, the Monetary Authority of Singapore (MAS) uses this (S$NEER) to adjust the strength of the Singapore dollar with its other trading partners so as to manage and regulate inflation in Singapore and maintain price stability which is essential for businesses to grow.
A neutral stance on the Singapore dollar means that it is neither appreciating nor depreciating when compared against a basket of its trade weighted basket of currencies of Singapore’s trading partners.
On 14 April this year, the MAS announced that it was taking a neutral stance. As Singapore’s economy continues to slow in 2016, it cannot continue to maintain an appreciative stance as foreign reserves will need to be used to shore up the exchange rate, hence the MAS’ neutral stance on the Singapore currency. This means that the Singapore dollar is less likely to appreciate by much against the Thai baht, unless the baht depreciates against most currencies. Thailand is Singapore’s 10th largest trading partner.
Thai baht versus other regional currencies
A country’s currency is very dependent on the strength of its financial system. Some ways to measure a currency’s susceptibility to being attacked by speculators include monitoring government absolute debt, debt to GDP, foreign currency reserves, inflation, elevated stock market and property prices, and a distorted market (i.e. pegged interest rates; pegged currency
exchanges, etc.).
Thailand has the largest economy out of these four countries, a high foreign reserve and a manageable budget deficit of 2.5 percent (most countries run budget deficits. It has run trade surpluses for most of the last 10 years.
Figure 3: Comparing the strength of Thailand’s economy versus Malaysia, Cambodia and Myanmar
Cambodia and Myanmar are undeveloped economies, hence a debt of 20 to 40 percent of GDP is considered high. But for a more developed economy such as Thailand, less than 50 percent government debt-to-GDP is considered low. The external debt is also manageable. Thailand’s household debt rose to 71.6 percent in Q1 2016, but this is nonetheless still manageable. The house price index is also high, which is expected during prolonged periods of economic growth.
Capital inflow in 2016 has not been strong, and we can only surmise that it may be neutral or negative. If there is capital outflow, this shows that the Thai economy is weathering the outflow of capital well without shocks to its economy.
As at June 2016, Thailand’s stock market is not at its peak, hence there is not enough “fuel” to ignite any arbitrage opportunity, and hence, is less risky. The property index is high, but it may not necessarily indicate an overpriced situation as Thailand is a major tourism destination, and becoming more internationally connected. In addition, properties are illiquid and less likely to lead to a currency depreciation.
Of course, there are other factors to consider as to whether a currency will remain strong or weak, such as politics, social factors, technological innovation, environmental factors and laws.
All these affect currency values, especially political events. Nonetheless, Thais have never been known to attack foreigners during previous internal political conflicts.
Where will the Thai baht head versus the Singapore dollar?
The Thai economy is still headed for growth in the vicinity of three percent in 2016 and beyond, while Singapore is headed for below two percent growth. Singapore’s neutral currency stance
means it is unlikely to appreciate strongly against the Thai baht, which has one of the lowest budget deficits in the region, strong foreign reserves, and manageable government debt-to-GDP.
Thailand also has low interest rates to stimulate and support their local companies. Although corporate indebtedness is hard to track, the removal of a pegged currency exchange relieves much of the built-up risk of US dollar debt and baht earnings that can put businesses at huge risks.
The fact that Thailand has maintained a low domestic interest rate that is able to persist speaks volumes about its financial strength. Today, Thailand is the strongest economy in the Indochina region with a strong trade surplus, and has transformed itself from being a purely agrarian country into an industrialised one.
Figure 4: Comparison of non-performing loans in some countries with total gross loans
Thailand’s non-performing loans are less than three percent, hence, are considered manageable.
Overall, the performance of the Thai baht compared with the Singapore dollar is neutral, but may slip in value with continued global economic weakness. However, it should be quite stable against the Singapore dollar considering that the MAS takes a neutral stance against its trade weighted basket of currencies. The Thai economy, along with the Singapore economy, is headed for slower growth like the rest of the world.
Paul Ho is the founder of www.iCompareLoan.com
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