Thailand heads in wrong direction with bond tax -IFR

October 18, 2010

(This article was in IFR Asia magazine, a Thomson Reuters publication, on Oct 16)

By Prakash Chakravarti and Umesh Desai

HONG KONG – Thailand’s move last week to reintroduce withholding tax on government bond holdings comes as policymakers across the region take steps to restrain capital inflows after a sustained rally in Asian currencies. However, there are doubts if these measures will do enough to deter investors in search of yield, and market participants are calling for tax cuts – not hikes.

In what many analysts believe is likely to be an ineffective attempt to arrest an appreciation of the baht, Thailand’s Ministry of Finance last week announced the reintroduction of a 15 percent withholding tax on foreign investments in government debt.

The move appeared to in response to the baht’s 11 percent rise year to date – to its strongest level against the US dollar since the 1997 Asian financial crisis – due largely to supposedly speculative inflows.

Thailand’s move, which comes five years after the tax was scrapped, has renewed concerns that Asian countries may impose restrictions on bond market investments in a bid to stem currency appreciation.

Foreign inflows to domestic currency debt in Indonesia, South Korea, Malaysia and Thailand had reached a combined $38 billion as of the end of August, compared with $26 billion in the corresponding period in 2009.

Market watchers quickly predicted the tax would have little impact on the currency, but warned that the measure would damage Asia’s funding markets.

“These taxes are not good for the domestic bond markets,” said Nicholas de Boursac, CEO of the Asia Securities Industry & Financial Markets Association. “Withholding taxes … result in increased cost of funds and are taxes on the issuers, not the investors. Moreover, they also reduce the liquidity in the domestic bond markets.”

Although yields in the Thai domestic bond markets spiked significantly ahead of the announcement — 10-year bond yields rose 25 bps to 3.15 percent, while five-year yields went up 23bp to 2.76 percent — the move reversed quickly and the impact was limited.

“We don’t think the reintroduction of withholding tax would cause a significant capital flight as the general outlook for Thailand remains attractive,” said Wee-Khoon Chong of SG Asia in a research note.

Indeed, Thailand’s announcement is reminiscent of a similar move Brazil made in October last year when the government imposed a 2 percent tax on foreigners buying local bonds to stem the real’s rise, but to little effect.

Earlier this month, Brazil doubled the so-called IOF tax to 4 percent, but many predict it will still have little impact.

Elsewhere in Asia, market participants are hoping that taxes will be dropped, rather than increased.

India is rumoured to be considering scrapping withholding tax for borrowings of infrastructure companies in an attempt to plug a huge funding gap.

Estimates suggest that India’s infrastructure sector has funding requirements in excess of US$500bn over the next five years, and regulators are said to be considering a withholding-tax exemption for long-term bonds.

That would make it more attractive for foreign investors to participate in infrastructure projects, opening up an alternative to the country’s domestic banking system, but market participants are calling for more drastic action.

“The withholding tax on foreign investments in government bonds should be done away with as it has no net positive impact on government finances as whatever revenue is collected from the tax is generally offset by increased interest payments,” said de Boursac.

He added: “India should consider broadening the exemption of the withholding tax beyond infrastructure bonds and make foreign investment in government securities also withholding tax-exempt.”

Withholding taxes have crimped the development of India’s domestic capital markets, together with restrictions on the tradability of the Indian rupee and a US$20bn cap on foreign institutional investments in rupee debt.

Withholding taxes make it difficult for Indian companies to access the international debt capital markets, as the issuer needs to compensate investors for the tax obligation in the form of an increased coupon. Indian borrowers are typically unwilling to do so, while the country’s external commercial borrowing regulations set a cap on interest costs that often makes higher coupon payments impossible.

South Korea last year made Korea Treasury bonds exempt from withholding tax, while the Philippines in September waived withholding tax on a Ps44bn ($1.02 billion) 10-year peso-denominated Global bond. The deal met with an overwhelming response from foreign investors and closed almost 13 times oversubscribed.

Following in the footsteps of the sovereign, San Miguel Corp-affiliate Petron is rumoured to be eyeing a peso Global.

Indonesia, which also imposes a 20 percent withholding tax, is said to be planning a domestic currency Global in a highly anticipated deal.

It is not clear if Indonesia will follow the Philippines example and waive the tax, but Thailand’s restoration of theb withholding tax, perhaps, makes that less likely.

Still, there is no denying that government officials across Asia are under pressure to stem the spikes in their currencies and withholding tax will look like an attractive option for some.

South Korean finance ministry officials were forced last week to deny rumours that withholding tax may be reimposed on foreign investments in Korean domestic bonds.

Despite the pressure on the won, it will be a big step to do so as the country is bidding to have its bonds included in the World Government Bond Index. Malaysian Government bonds are already part of the index and it, too, will find it difficult to reintroduce withholding tax.


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