The Bank of Thailand may win this round of the currency battle, but confidence must be rebuilt quickly, Thanong Khanthong reports.

The outcome of this round of the bloody currency contest should favour the Bank of Thailand, which is fiercely defending the Thai baht against heavy assaults by foreign speculators.

The strategy of keeping the cost of borrowing the baht to a prohibitive high has worked to a certain extent. It has punished the foreign speculators, who have sold the baht short for the US dollar with hopes of pocketing profits from the weaker baht, if not a baht devaluation. Intense speculation on the baht on the back of the dollar appreciation has sent the Thai currency to continued lows.

The spot market rate hovered between Bt25.980 to Bt25.985/dollar, while the BOT's mid-rate was pegged at Bt25.920/dollar. On Monday Feb 3, the mid-rate stood at Bt25.86/dollar. In one week the BOT lost some ground, with the dollar moving in the opposite direction to touch ¥124/10, a record four-year high against the Japanese yen.

''It is not surprising then under these circumstances to see a prolonged and heavy baht outflow from the Thai financial system," a report by Thai Farmers Research Centre Co Ltd said. Capital outflows reduced between Feb 5 to Feb7, when the Hong Kong and Singapore foreign exchange markets were closed for the Chinese New Year holiday.

Yet the Thai Farmers report was critical of the BOT over its failure to foresee heavy selling of the Thai baht before the Chinese New Year. ''What the central bank did not anticipate was the selling of the baht in those two markets right before their holidays, seriously affecting the Thai market over the latter half of the week," the report said. ''Moreover, there was heavy baht selling in New York, which worsened the value of the currency."

The BOT, however, moved quickly to order the cash-rich Government Savings Bank to withdraw its lendings from the interbank market. With the absence of the savings bank, a large pool of liquidity has been drained from the system, resulting in a big jump in the interbank market rate to 30 per cent on Friday.

The savings bank inadvertently did a disservice to the country because it was lending out its money largely to foreign banks, who mostly needed the Thai baht in order to sell it short for the US dollar.

The goal of the BOT is to force foreign banks to release the dollar from their mouths, which will improve the baht liquidity. Yet the foreign banks turned around to take on the finance companies by recalling their money. This led the interfinance market rate to soar to 40 per cent at the end of last week.

The aim of the foreign currency speculators is to create panic to the extent that Thai importers or Thai borrowers of foreign currencies jump head-long to scramble for the dollar to hedge their positions ­ due to investor confidence in the currency pegging system, most dollar loans are not hedged. Higher demand for the dollar will add further pressure on the Thai baht. So far, the foreign currency speculators have not succeeded in this big gamble by crying wolf.

However, if the exporters, who have gigantic dollar holdings at their disposal, or about US$40 billion a year (Bt1 trillion), decide to sell the dollar out for the baht, that should improve the pressure on the Thai currency. At this point, neither importers, exporters nor corporate borrowers of foreign currencies are doing anything because they are nervously watching the currency war from the sidelines.

''I don't think the currency speculators will win it in this round," Krairit Euchukanonchai, president of Thana One Finance & Securities Plc, who is a currency expert and was formerly treasurer at Citibank NA, said. ''But the BOT is battling a lone war against the foreign speculators without any help from exporters. If exporters sell the dollar out, that will make it difficult for the speculators to win this battle."

The G-7 finance ministers, who met in Berlin over the weekend, succeeded in putting a brake on the strong dollar rally after they signalled that the dollar has reached the end of its phase of upward correction. Yesterday the foreign exchange market in Tokyo responded by pushing the dollar down to Y120.35 at one point, a sharp decline of more than 4.0 yen.

The dollar decline has given the baht, tied to a basket of currencies that is 80 per cent dominated by the US dollar, some breathing room. Any dollar appreciation will put downward pressure on the Thai currency and make it more difficult for the BOT to defend the baht.

Nonetheless, the high interest rates have also had a side-effect on the Thai financial system. Since most of the 91 or so finance companies are net borrowers, they are suffocating from the sky-high costs of funds, ironically higher than the lending rates they have offered. Last Friday was Chinese New Year's Day and most of the players in Singapore and Hong Kong were off for a holiday.

Smaller banks and finance companies were feeling the agony in their attempts to match their funding and set aside reserve requirements amid the skyrocketing rise in short-term interest rates. The Bank of Ayudhya, the fifth largest commercial bank, has raised its minimum overdraft rate from 13.75 per cent to 14.0 per cent.

Yesterday, the baht speculation appeared to subside. The interbank market rate eased to 22 per cent, compared to 25 to 30 per cent on Friday. The swap rate, or a premium for settling baht/dollar trading at a specified date, also declined to 42 satang for the bid rate and 46 satang for the offer rate, against 60 satang on Friday.

''The market is seeing some improvements without dollar buying pressure. In the meantime, neither is there selling pressure on the baht because the market is pretty tight," a dealer at a foreign bank said. ''I think once the players in Singapore are back from their holidays, the market should further improve tomorrow."

The BOT might briefly win a currency battle in this round, yet in the longer term it must be backed by renewed confidence in the Thai macroeconomy. Krairit of Thana One, who viewed that fundamentally the Thai baht is not overvalued, added that the government must move quickly to win back confidence by making sure fiscal spending is contained and the current account deficit is improved.

Today, Cabinet is set to table its plan for fiscal spending cuts, which will save at least Bt99 billion. The financial markets are closely watching whether the government is going to stick to this spending cuts package seriously as committed. Failure to follow through will destroy the momentum to stabilise Thailand's macroeconomic conditions.