Dealing with Capital Flows: Thailand in 2006

Abstract

This comprehensive case 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. (It was originally written as an exam case for first-year course, Global Economies and Markets).Late in the day on December 18, 2006, the Bank of Thailand (BOT), the countrys 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 USD20,000 for a period of one year. The restriction on capital inflows represented a significant escalation of Thailands battle to stop the appreciation of its official currency, the baht (THB). On December 19, the Stock Exchange of Thailand (SET) composite index droped 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, prompted Thai policymakers to reevaluate the situation and to consider policy options for 2007.