Thai Stocks Bounce Back, But Thailand's Credibility Suffers

Thai shares bounced back from their biggest sell-off in 16 years after the country scrapped capital controls on foreign stock buying.

But the abrupt policy U-turn shook investor confidence in Thailand's economic management, despite protestations from the country's finance minister that move is not a reversal and that the overall plan is still to deter capital inflows that are strengthening the baht.

Thailand's main index, the SETI, leapt 10.6% Wednesday, after the army-appointed government lifted controls on short-term baht inflows just one day after they had been announced. That led to a 14.8% plunge on Tuesday -- its biggest single-day sell-off since Saddam Hussein invaded Kuwait in 1990.

But the recovery is well short of the index's closing level Monday, before the Bank of Thailand (BOT) announced its drastic assault on the speculators it blamed for catapulting the baht 16% higher in 2006 against the U.S. dollar. Top most on everyone's mind is why impose capital controls to begin with?

There was a lot of money coming into commercial paper and short-term debt instruments, so the Bank of Thailand came up with measures to deter capital inflow, which was "really hurting our economy through the strengthening of the baht currency, to the point that our exports has become (not) competitive against our other friends in Asia," Thailand Finance Minister Pridiyathorn Devakula told CNBC Asia.

But given the effect on the stock market, the government decided to lift controls on equity investment, Devakula said.

"They (BOT) were thinking they needed to do something to keep the currency from relentlessly moving upward. Unfortunately, the choice they made to use capital controls was a fairly blunt instrument compared to what some of the other central banks in the region have been doing.", said Michael Kurtz, Asian Equities Strategist for Bear Stearns in an interview with CNBC's "Asia Squawk Box".

But a quarter-point interest-rate cut would not have been enough to counter $1 billion of capital inflows per week, Devakula said.

"We are the major recipient of capital inflow, compared to GDP," he said. "We've had our fair share. We want others to have a fair share as well."

Kurtz thinks that with this quick policy reversal, the Thai government may have avoided the complete surrender of their reputation in imposing the obviously unpopular measures in the first place.

Damage Is Done

Still, a lot of damage has been done in terms of scaring off foreign investors. At the close of business Tuesday, foreigners had already dumped a net $700 million worth of shares in a frenzy of cross-market selling and Thailand's reputation in the eyes of international investors was lying in tatters.

The sell-off evoked memories of Asia's 1997/98 financial crisis, which was prompted by a baht devaluation, but analysts aren't too concerned that this will have a sustained knock-on effect on markets in the rest of the region. "We wouldn't be spooked by what happened in Thailand. No one's seriously expecting capital controls out of the key countries like Taiwan, South Korea, China, India.", said Alec Young, Equity Market Strategist for Standard & Poor on CNBC "Asia's Squawk Box".

Young added that people are well aware that the situation in Thailand was already unstable given the recent coup and change of government in September. While the credibility of the government and that of the stock market have been shaken by the news, Young would not extrapolate this into an emerging-markets wide contagion.

Pressure On Currencies

Kurtz of Bear Stearns agrees with the assessment that other central banks in Asia are unlikely to resort to the drastic measures Thailand imposed despite the upward pressures many Asian currencies are facing including the Singapore dollar and South Korean won. This sentiment is echoed by many around the region.

"What we need to see are central banks reiterating their commitment to either accepting some degree of currency upside or slowing currency upsides through mechanisms that aren't as disruptive to the freeflow of capital and free exchange of assets on the open bidding market.", Kurtz commented on "Asia Squawk Box".

An yet inspite of the measures, or as some have said, the 'misstep' imposed by the BOT, Thailand's currency remained relatively unscathed during Tuesday's turmoil. The baht, the strongest Asian currency against the dollar this year, dropped as much as 2.5% from Monday's 9-1/2-year high in response to these measures. That's certainly not the results the BOT had hoped for and a far cry from the losses suffered by the SETI Tuesday.

Thai central bank chief Tarisa Watanagase reiterated that the central bank has no plans to cut interest rates soon to help slow the appreciation of the baht. "It is not the right time to cut rates as there are still risks from unstable oil prices and impending price rises for basic products that could fuel inflation," she said.

Under the original version of the rules, investors had to keep all sums over $20,000 not linked to trade or foreign direct investment in Thailand for at least a year or risk stiff financial penalties.

Reaction in the bond markets -- still subject to the new rule despite the reversal on stocks -- was swift as the headlong departure of international investors pushed yields up 20-30 basis points for all maturities.