The Bank of Thailand's monetary tightening move has succeeded in rectifying the distortions in the interest-rate structure, with the gaps between offshore and onshore rates narrowing significantly from over 4 per cent to over 2 per cent.

On May 28, before Chatu Mongol Sonakul was sacked as central bank governor, the differential between one-month offshore and onshore rates stood at 4.15 per cent (6.47 per cent offshore versus 2.32 per cent onshore). The three-month gap was 4.57 per cent (7.11 per cent offshore against 2.54 per cent onshore) and the six-month spread was 4.14 per cent (6.84 per cent offshore versus 2.70 per cent onshore).

These huge gaps, resulting from capital controls imposed by the central bank and artificially low interest rates in the local market, distorted the financial markets and encouraged banks and companies to take their money overseas. Shortly after Pridiyathorn Devakula became the new governor, he ordered a hike last Friday in the repurchase rate by one full percentage point to 2.5 per cent.

On Monday, following the abrupt adjustment of local rates, the gap between offshore and onshore rates was almost cut in half - to over 2 per cent.

"The onshore rates made a quick upward adjustment after the dismissal of Chatu Mongol. The offshore rates remained unchanged but only began to move downward after the repurchase rate adjustment on Friday," a currency expert said.

On Monday, the one-month onshore rate stood at 3.49 per cent, compared to 5.59 per cent for the offshore rate. The three-month onshore rate hovered at 3.45 per cent, compared to 6.23 per cent offshore. The six-month domestic rate was quoted at 3.63 per cent, compared to 6.33 per cent offshore.

"After the dismissal of Chatu Mongol, the central bank, sensing a radical shift in monetary policy, did not dare to intervene in the money markets by keeping the interest rates artificially low like in the past," a Government House official said. "As a result, the onshore interest rates have begun to move according to market forces."

The primary aim of the central bank in resorting to its interest rate weapon was to deter baht speculation in the foreign-exchange swap market. With the low rates in the interbank and repurchase markets, local banks have rushed to the foreign-exchange swap market to get a hold of dollars and deposit them in offshore markets at a 4-per-cent interest rate.

After deducting the pre-interest rate hike swap cost of 1.25 per cent, local banks made 2.50 per cent, compared to the 0.50- to 1.25-per-cent they could get in the overnight interbank market. This was one of the distortions that led to capital outflows.

The big winners from this round of interest-rate rises are the local banks, which are flooded with excess liquidity.

Analysts said the forward premium for baht/US dollar conversions had fallen to one to three satang, or almost no cost at all, giving Thai banks the chance to score a net gain of 4 per cent by depositing dollars overseas.

Thanong Khanthong