Despite the central bank's triumphant declaration, analysts expressed some doubts about the policy's actual impact on capital movement and its benefits to economic stability.

The rate increase served its purpose in decelerating companies' foreign debt repayments and encouraging commercial banks to bring back foreign assets.

The decrease in capital outflows has improved the central bank's confidence in foreign-exchange stability at a time of a narrowing current account surplus.

But analysts said the effects of an interest rate increase alone on capital inflows would be minimal, given that several other factors were involved.

The central bank has said that official reserves, which have been steady since the end of July at around $32 billion, were sufficient to ensure economic stability, considering the amount of short-term foreign debt.

Prior to the interest-rate increase, higher offshore interest rates and the weaker baht had created incentives for companies to refinance their debt with local borrowing, either from the banking system or the bond market.

The impact of the increase in the central bank's interest rate has been to reduce foreign debt repayments to around $500 million a month from a previous average of $800 million to $1 billion per month.

The country's foreign debt fell to $71.4 billion by the end of the third quarter, from $79.7 billion at the end of last year. The central bank itself is responsible for some $10 billion in loans sponsored by the International Monetary Fund.

The current policy of high interest rates relative to those in many other countries contradicts the beliefs of some economists of the traditional school. They argue that interest rates must be adjusted lower to spur consumption and investment, while accepting that a little inflation is healthy for private investment and tax collection.

But the central bank has argued that reducing interest rates would have only a slight impact on the banking system and in stimulating the domestic economy.

The excessive liquidity in the money market, which is currently estimated at 500 billion baht, would erode the impact of interest rate policy on the market, it said.

Meanwhile, the slowing global economy is causing Thailand to rely less on exports as the main engine of growth. As a result, a strengthening baht could have less of an impact on growth than it might have had two years ago.

The interest rate increase had also been used as a tool to slow down local banks' reductions of deposit interest rates.

But they could no longer resist the pressure to cut deposit rates in December as the fragile economic recovery had contributed to the low credit demand.

The Sept 11 events also prompted central banks in major Western countries to start cutting rates even more aggressively in an attempt to revive growth and shore up consumer confidence and spending.

The US Federal Reserve has been cutting rates for months, and 11 reductions since the start of the year have left its key policy rate at 1.75%, the lowest level in 40 years and down from 6.5% in January.

The Fed argues that by loosening monetary policy, the expansive fiscal stimulus has helped lessen the chance of the world economy slipping into a recession.

Thailand's central bank continues to resist a similar approach, despite the fact that the lower overseas rates have provided it with increasing room to act, in order to sustain economic recovery without risking capital outflows.

The resistance has come despite concerns that it could result in higher local interest rates that might become a drag on economic recovery.

However, the central bank governor, M.R. Pridiyathorn Devakula, said in November that he would consider an interest rate reduction if economic projections in the next year were revised downward.

In any case, analysts expect the central bank to cut its rates along with the Fed in the next year. They also expect the Fed to further reduce interest rates by at least 0.5% in the next year.

The current benign inflation, as a result of the weak economy, would also support any central bank decision to cut interest rates. The central bank expects inflation to average 1-1.5% in 2001, increasing to 1.5-2.5% in 2002, when the economy is forecast to recover.

It projects the economy would grow between 1% and 3% in the next year, providing that major trade partners' economies recover no later than the third quarter.

With economic forecasts for its major trade partners looking grim, the central bank expects export growth to contract by 6% in 2001.

The worse-than-expected economic growth figures this year have had a negative impact on banks' lending, with loans showing only 0.3% growth in October.

As a result, several commercial banks reduced deposit interest rates in late November, with the average savings interest rate at 1.75-2% and three-month fixed deposits at 2.25-2.5%, against a lending interest rate of around 7%.

CURRENCY TRENDS

The Sept 11 incidents and the deteriorating economic prospects weakened the dollar and made the stock market tumble.

The baht, which had been on an appreciating trend since the June interest-rate hike by the central bank, gained ground after Sept 11 as the dollar fell against most major currencies.

The weakening dollar enabled the central bank to buy dollars to consolidate official reserves in the third quarter.

Meanwhile, the sluggish recovery of the Japanese economy and its banking system has contributed to the depreciating yen.

It reached a three-year low in December, due to the unsolved weaknesses in its financial sector.

The baht hit a high of 43.80 to the US dollar on Dec 17, compared with the year-low of 45.78 in early July. But the central bank expects that any appreciation of the baht would have only a slight impact on the country's exports.

The decline of exports has been milder than in other regional countries, as Thailand benefited from a more diversified economic base. Singapore, for example, is heavily reliant on electronics and has seen its non-oil exports fall in value by more than 20%.

Portfolio investment flows in the fourth quarter also helped strengthen the baht against the US dollar.

The central bank has maintained that the baht was not excessively strong when compared with regional currencies.

But it is expected to slow the buying of dollars as in doing so, it would have to inject more baht liquidity in the market, which is already flush with liquidity.

Analysts said the central bank's monetary policy stance, current economic conditions and the development of the US economy would be important factors in determining the value of the baht over the next few months.

THE BOND MARKET

The bond market had been volatile in June due to uncertainty over the interest rate trend. But it benefited from the deteriorating economy as investors expected a downward trend in interest rates and the postponement of a government bond issue, worth 320 billion baht, to the end of 2002. Analysts said the postponement would prompt the central bank to absorb liquidity from the system if it wanted to defend its interest-rate policy.

The government at the end of 2001 was preparing to issue 35 billion yen in Samurai bonds, its first foreign-denominated paper since the 1997 economic crisis. It expects to issue more bonds in 2002 to fund the deficit and reduce the debts of the Financial Institutions Development Fund.

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