International Finance Course project Research Paper

International Finance Course project - Research Paper Example Since early 2006, The BOT tried several policies to curb the phenomena but to no avail, and in the end, in December 2006, it introduced this policy. Below is a more detailed discussion of this. After 2004, as access to credit became easier in developed countries due to lower interest rates, investors began to look for opportunities to invest in developing countries where the interest rates were high. As a result, nearly all East Asian countries had high inflows of foreign investment, as did Thailand. While this investment can help in the development of countries, they can be equally discouraging and even disastrous if bulk of these investments are short-term and speculative in nature. The reasons for this are explained below: 1) Local currency appreciation: With more inflow of foreign investments, the local currency tends to appreciate making local exporters less competitive. 2) Large inflows: Large injections of investments in a small economy can cause distortions and even havoc if pulled out suddenly 3) â€Å"Hot money†: If the investments are pulled out suddenly, the economy can crash 4) Asset bubbles: Large investments in one sector can cause unsustainable growth on sector assets (example real estate) 5) Household credit: With inflows, households tend to borrow more leading to high household debt than they can possibly service In 2005 and 2006, Thailand saw unprecedented increase in capital inflows. This is illustrated below in table 1. However, as the FDI component (long term investments) was not in line with all the investments, it was clear that most investments are short-term in nature. Also, according to the Bank of Thailand, a large part of this money was going into currency (Thai Baht - THB) speculation which is illustrated by the continuous appreciation of THB against the US Dollar (USD) as shown in Figure 1. Table 1 Annual Flow of Foreign Investment in Thailand 2003 2004 2005 2006 Current Account 4784 2767 -7852 3240 FDI 4608 4952 7297 9563 Debt securities -827 17 487 -267 Equity securities 583 180 2158 4744 Others (Corporate & government loans + trade credit) -9293 -7232 3042 3758 Total -145 684 5132 21039 Source: FPRI Both 2005 and 2006 saw a huge increase in investments in equity securities, which is typically a short-term investment. While the FDI did register and increase, it was relatively only a small proportion of the total flow of capital. Figure 1 Exchange rate of THB against USD from mid 2005 to December 2006 As seen in figure 1, on the left, the THB was continuously appreciating against the USD from around 42 THB/USD to below 36 THB/USD. This appreciation of the THB meant that the local companies were losing competitiveness. The BOT tried several policies to prevent appreciation of THB, was unable to stem it. The key measures tried were (BOT 19-20) â€Å"Permitting a larger amount of residents’ investments abroad, as well as discouraging short-term capital inflows through raising the total permissib le outstanding balance in the foreign currency deposit (FCD) accounts of corporate residents. On 4 December 2006, the Bank of Thailand implemented measures on short-term capital flows which required non-residents to hold securities for longer than 3 months and allowed domestic financial institutions to borrow baht from non-residents without underlying trades or