01 Oct 2006, Asia Risk
Asian markets woke up on September 20 to shocking headlines of a military coup in Thailand against prime minister Thaksin Shinawatra, while he was away in New York. Army tanks had reportedly surrounded Thaksin's office in Bangkok, while the military also seized control of television stations. An announcement on national television on behalf of army commander-in-chief Sondhi Boonyarataklin said martial law had been declared across the country and that a Council of Administration Reform with King Bhumibol Adulyadej as head of state had seized power without resistance (see box). The consensus among market participants is that the overall impact on investor sentiment will be relatively minor - but the credit market has been significantly affected.
The news rattled Asian markets, causing credit default swap (CDS) spreads on Thai sovereign bonds to widen to as much as 70 basis points on September 20 from 36bp a day earlier, before stabilising at around 45-50bp by the end of the month. Dealers say the news has also generated demand for protection on Thai corporate bonds, with normally illiquid CDSs on five-year US dollar sub-debt of energy group PTT offered for about 57bp since late September.
On the same day, Fitch Ratings placed Thailand's sovereign ceiling rating of A- on watch negative. Standard & Poor's (S&P) also placed the foreign and local currency ratings of six Thai corporates on credit watch with negative implications: Electricity Generating Authority of Thailand; PTT Public Co; PTT Exploration & Production Public Co; PTT Chemical Public Co; Thai Oil Public Co; and the Aromatics (Thailand) Public Co. Both S&P and Moody's Investors Service warned that Thailand's debt ratings may be cut, although Moody's said it saw no "immediate risk of an external payment crisis". Moody's affirmed its Baa1 foreign and local currency ratings for the Thai government, A3 foreign currency ceiling for bonds, Baa1 foreign currency ceiling for bank deposits, as well as ratings on nine Thai corporates.
Political risk has already been priced into Thai bonds, as there had been uncertainty over Shinawatra's leadership for several months running up to the coup, says Nattawut Sachabudhawong, economist at Siam Commercial Bank.
But given the uncertainty over the future credit ratings of Thai issuers, this may push them to find funding quicker, he says. "Given that the bond price level fell by around 15 to 20 basis points in the few days after the coup, issuers will have to pay a small premium," says Sachabudhawong. "This may be interesting for CDO issuers, because if some good names come out, investors can get more returns from a Thai bond than a bond in the same rating category outside Thailand."
Others agree that Thai bonds remain attractive to investors. "Sovereign credit default swaps are 10bp wider than before the coup," says Jacob Hoare, director, structured credit products in HSBC's global markets group in Hong Kong. "But the unfortunate thing from a collateralised debt obligation (CDO) perspective is that apart from Thai sovereign credit and PTT bonds, the market is illiquid. In terms of credit choice for a US dollar investor, there really isn't much variety.
"The impact from the coup on a 100-name CDO with Thai exposure will be minimal compared to phenomena such as leveraged buyout speculation in the global telecoms space," adds Hoare. "Thai names are definitely interesting, but 10bp can happen to a lot of credits, and there are 30 to 40 other European or US names with similar ratings I could suggest to replace in your portfolio."
While the Thai exposure, if any, found in synthetic CDOs will typically be small, the main issue will be correlation risk in the underlying portfolio. "Another issue with Asian credits is that they are more penal on the recovery side and on the correlation side," Hoare says. "So if there are 100 names, and you have Thai, Indonesian and Malaysian exposure, if you add more Asian names, correlation risk could become an issue."
Most analysts feel that an actual downgrade of Thailand's sovereign ratings looks unlikely at this point, given a robust economic outlook and a calm political transition. "Even after the military coup, the view on Thailand is pretty buoyant, with the markets appearing to take developments so far in their stride," says James McCormack, head of Asia sovereigns at Fitch Ratings in Hong Kong. "In terms of economic fundamentals, not much has changed. We're monitoring the situation, which remains fluid, and that is why we placed Thailand's rating on watch."
Taking stock of the coup
The Stock Exchange of Thailand had a muted response to the political situation. The exchange was ordered to close by the military on September 20. The benchmark stock exchange of Thailand (SET) index closed at 702.56 points the day before, and on September 21, it closed 1.4% lower at 692.57 points and had dropped to 686.1 by the end of September.
Meanwhile, trading on the Thailand Futures Exchange (Tfex) in fact posted a record high on September 21, with 3,623 SET50 index futures contracts traded on the day. Kesara Manchusree, managing director of Tfex in Bangkok, says the stock market volatility has significantly boosted demand for futures. "We think investors used futures as a hedging and trading tool against price volatility in the market," she says.
Investors remain bullish on Thailand's stock market, adds Manchusree. "Futures prices indicate people have a good outlook for the Thai markets. The data also shows that foreign investors were net buyers last week," she says. The coup is not likely to have a long-term effect on the equity and futures markets or on foreign investment in the Thai market, adds Manchusree. "Up to this point, there was a great deal of political uncertainty, but after the coup was announced and the public was aware of the direction of the political situation and economic policy, most of the issues were clarified."
"We are going to have a new prime minister within a week," she says. "A new cabinet will be appointed soon. An election is scheduled for next year. Thus, there should be less uncertainty for the investors to worry about."
Others are also upbeat. "The limited selling is due to the fact that the political instability started almost a year ago and Thai equities were being sold down since the start of the year," says Mun Hon Tham, regional strategist at ABN Amro. "The current 12-month forward price/earnings ratio of 9.5 is only about 10% of the valuation the market traded at during the Sars crisis. Thus, there is downside protection in the form of attractive valuations."
As for currency markets, the Thai baht weakened on news of the coup. It depreciated from 36.30 baht to the US dollar on September 18 to THB37.79 when news hit the market on September 20. Since then, the baht has traded at around 37.53 to the dollar. For the time being, analysts remain confident that any depreciation of the baht would be fairly contained, given the Bank of Thailand's record-high $59.4 billion in foreign exchange reserves. At the same time, foreigners cannot be short more than 300 million baht on an overnight basis, so fear of money flight is also low.
But whether enough buffers have been built into CDS spreads, the baht or equity markets will depend on how quickly the government returns to normal, say analysts.
THE CURRENT SITUATION
The Thai military announced an interim prime minister and constitution on October 1, with retired general Surayud Chulanont taking the role under a gradual plan to restore democracy. The interim constitution - read out over the television and radio stations by King Bhumibol Adulyadej - absolves the Council for Democratic Reform (CDR) led by Sondhi Boonyarataklin for staging the coup.
The CDR will become into a new body - the Council for National Security (CNS) - authorised to appoint the interim prime minister, the national legislature and oversee national security until general elections are held. Boonyarataklin also said general elections, initially scheduled for this month, would be postponed to October 2007, after a new permanent constitution is in place.
Meanwhile, ousted prime minister Thaksin Shinawatra is now reportedly living in exile in London. The downfall of Thaksin's government, which had been in disarray for months, started with the controversial sale in March of $4 billion of Thaksin's telecoms assets to a consortium led by Singapore's Temasek Holdings. Some 50,000 outraged Thais took to the streets of Bangkok to protest against the sale.
Public pressure forced the prime minister to step down temporarily and call new elections in April. But results of the April 2 elections were annulled, and members of the election commission were subsequently sentenced to prison for rigging the votes in Thaksin's favour.
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