The baht has strengthened more than regional peers this year partly because of the country's strong foreign currency reserve position. A short-term correction seems to be in the making but the baht appreciation trend could resume down the road.
The market consensus is the US dollar has peaked and this should lead to stronger emerging market currencies this year. However, now that the baht-dollar exchange rate is already in the expensive zone, we see a slim upside. Historically expensive boundaries of 1.5 to 2 standard deviations (SD) reflect more extreme fund flow conditions (2007 and the first quarter of 2013), which do not seem likely under current circumstances.
Our regression models correlating the baht-dollar and foreign-currency-reserves-to-GDP ratios (R2 87-89%) suggest that with reserves currently at $208 billion ($240 billion including forwards), fair value for the baht should be around 32.8 to 32.9 to the dollar (plus or minus 1.6 baht within one standard deviation over the past five years). An addition of $10 billion to foreign reserves would shift fair value by 0.49 to 0.57 baht.
The current exchange rate of 31.3 is already one standard deviation below the fair value. We have not seen sizeable inflows into Thai bonds (7.5 billion baht in outflows for the year-to-date) or equities (7.4 billion baht in inflows).
Expensive Thai bonds (the current 10-year yield of 2.45% is just 15 points below 10-year US Treasuries) could reduce pressure on the baht. Dollar selling by exporters could have caused the quick appreciation in January. Without additional flows into investment assets, the speed of baht appreciation could be slower down the road, with limited scope as the baht is already expensive.
MIXED IMPACT
Assuming appreciation of 1 baht to the dollar, or 3.2% (also assume 3.2% against the euro and 2% against the yen), the net impact on aggregate core earnings of stocks covered by Bualuang Securities is -1.3%, with -0.4% impact on net earnings. The current exchange rate of 31.3 is slightly stronger than analysts' modelled assumption of around 32.2, implying potential changes to earnings estimates if the baht does not weaken back to that level.
Many companies will see offsetting impacts from the stronger baht to their core earnings and net profit. Those that hold dollar-denominated debt will see benefits from the strong baht, offsetting lower core income from their dollar-linked revenues.
Among the sectors expected to take the worst hit to core earnings from a strong baht-dollar rate are electronic components, petrochemicals, shipping and energy. However, the latter three sectors have dollar-denominated debts that incurred foreign-exchange gains to offset negative impacts to core earnings. Electronic components companies do not have sizeable dollar debts, thus their net profits are most affected. Among the key beneficiaries from a strong baht are airlines and net importers (such as TVO).
We use simple correlation models between the baht-dollar rate and foreign reserve ratios to determine where the exchange rate stands. The models suggest that fair value is 32.8 to 32.9 to the dollar with a 1SD zone of +/-1.59 baht (five-year historical data; alternatively for three-year data the 1SD zone is +/-1.44/baht).
Foreign reserves expanded again the past few months after softening in the second and third quarters of 2018. The ratio of reserves to GDP has inched up as the baht appreciated quickly, offsetting higher GDP. Thailand's higher current account to GDP ratio (about 7% in 2018) and foreign reserves to GDP at 40% have been supportive of baht strength, and these ratios appear poised for a gradual uptrend in coming months.
As the recent appreciation in the baht to 31.3 has swung below the regression line by around 1SD already, further upside could be limited. Extreme levels in the past were 1.5 to 2SD below the regression line, but these periods were quite brief and proved unsustainable.
The baht may continue to rise in the short term along with some regional currencies that may also strengthen. History suggests that it can swing near to the 1.5SD level (or around 30.5 to the dollar) before reverting to fair value at the regression lines.