The central bank had hoped that squeezing baht liquidity in the offshore market would discourage foreigners from speculating on the baht.

One expert, who asked not to be named, said the BOT's remunerated reserve requirement of 30 per cent had dried up baht liquidity in the offshore market, because local banks can only sell dollars for baht in the offshore market. They cannot do reverse transactions in the offshore market, and hence the baht has continually flown back to the onshore market. This has caused the local currency to strengthen by as much as Bt2 to the US dollar in the offshore market compared with the onshore market.

Yesterday, the baht in the onshore market opened at 35.85/35.89 and closed at 35.80/35.83, while the baht in the offshore market about 5.15pm Thailand time was at 33.90. Before the draconian measure took effect on December 19, the baht in both markets had been quoted at very close prices.

The central bank has been optimistic that the gap in the value of the baht in both markets would disappear some day.

The source said speculators would finally find a loophole to bring baht out of the country and lend it to non-residents at a high interest rate in the offshore market to make profits.

"The more the gap widens, the more the baht is attractive to be arbitraged. The dam [set by the BOT] can separate only part of the water. The speculators must find the way to break the dam at last," he said.

A dealer from one commercial bank said the draconian measure might encourage speculators to arbitrage the two currencies by buying cheap dollars in the offshore market and selling in the onshore market. The gap will lure speculators to breach the rule.

Bank of Ayudhya executive vice president Tak Bunnag agreed that once there was a gap in foreign exchange between the two markets, it was a chance for arbitration.

"Once prices are distorted or unreasonable, speculation is possible. Right now, the spread of the baht between the two markets is about Bt2, which is quite attractive for speculators," he said.

Not only banks can do foreign-exchange arbitraging; so can other financial institutions, such as funds or even non-finance organisation. People who are not under control of the central bank are probably those who speculated in baht, and some of them are probably bank customers whom the banks recommended take advantage of the chance to arbitrage, he pointed out.

However, TMB Bank executive vice president Satian Tantanasarit said baht arbitration between the two markets was virtually impossible. It is very difficult to be done, he said.

"It can be done by carrying cash abroad, but that's quite impossible in practice," he said.

People who seek to arbitrage the baht must have a large amount of the currency in their hands. Although local banks are qualified, they are strictly prohibited by the BOT. Foreign banks do not have much baht in their portfolio either, while Thai exporters hold mainly US dollars, he said.

Siam Commercial Bank executive vice president Pakorn Peetathawatchai believes the baht arbitration between the two markets is impossible, considering both the trading volume and the baht rates.

"If there were arbitration, the rate gap of the baht between the two markets would be narrower rather than wider like what has happened," he said.

Meanwhile, the BOT yesterday issued a notice to banks reminding them it remained opposed to non-deliverable forward (NDF) transactions in the baht.

Though the volume of NDFs isn't high, its use by some players in response to tight offshore-baht liquidity reduces the effectiveness of the central bank's recent measures against currency speculation and its ability to monitor real investment inflows.

Typically traded offshore, NDFs are short-term derivative instruments that allow corporate and other types of investors to hedge or take an exposure to local currency movements without actually dealing in the underlying currency.

Some foreign banks abroad that have obligations to deliver the baht to their counterparts avoid borrowing the expensive baht offshore by netting their obligations in terms of dollars partly or totally, which is called an NDF. As a result, they do not need to pay in baht, or at least pay only in small amounts.

Suchart Sakkankosone, a director of the Financial Markets Operations Group, said the baht would be affected if the volume of the net settlement were large.

 He said transactions to roll over existing contracts or wind down positions after default by a counterparty were exempted from the ban.

Meanwhile, the BOT yesterday officially announced further relaxation by exempting general foreign-currency borrowings, intercompany loans and foreign capital derived from debt instruments issued from capital-reserve requirements. These loans must be fully hedged by foreign-exchange or cross-currency swaps.

Exempted are packing credit with maturity of less than 180 days and warrants, transferable subscription rights and depository receipts, in addition to stocks traded in the Stock Exchange of Thailand and the Market for Alternative Investment.

Anoma Srisukkasem,

Somruedi Banchongduang

The Nation