The baht yesterday continued to gain ground against the US dollar despite intervention by the Bank of Thailand. The currency strengthened to as much as 33.45 to the dollar yesterday, up from 33.77/80 on Monday. The baht has gained 7% against the dollar so far this year.

Central bank governor Tarisa Watanagase said the appreciation of the baht stemmed from capital inflows by investors in the stock market, and urged exporters to not panic and dump dollar holdings.

Capital inflows were affecting the entire region, she said, and added that any move by the central bank to weaken the baht against the market trend could spur even greater inflows and speculative activity.

Dr Tarisa said the central bank was ready to intervene in the currency markets to help smooth volatility. In any case, regulators expected the baht to weaken in the second half of the year as exports slow and the current account surplus shrinks.

"There are expectations that the baht will weaken later in the year, in contrast to earlier projections that the baht would continue to strengthen," Dr Tarisa said, pointing to signs of a recovery in imports in April and May.

She added that investors should exercise caution given the rapid bull run in the stock market. The SET has been one of the hottest markets in the region this year, with the main market up 23% over the past three months.

From January to July 6, a total of $22 billion in capital has poured into Asia, helping push many regional markets to all-time highs.

The Stock Exchange of Thailand alone has seen foreign investors hold a net buy position of 120 billion baht for the year to July 9. "If you ask whether capital inflows into the stock market represent speculation on the baht and stock prices, the answer is a bit of both," Dr Tarisa said.

"Yes, there are some who are investing due to the country's strong economic fundamentals and hold a long-term view. Other flows represent hot money for speculation. Retail investors should exercise caution."

The strengthening baht has raised fears over the sustainability of export growth and the impact of shrinking profit margins on local firms, particularly small and medium-sized companies and manufacturers that depend on local content.

Exports have been the main engine for economic growth this year, rising some 18% in US dollar terms for the year to date. Dr Tarisa said the central bank would target the interest rate policy at inflation rather than exchange rates, adding that the relationship between interest rates and currency rates was uncertain.

"There is no certainty that an interest rate cut would result in fewer inflows," Dr Tarisa said. The central bank's Monetary Policy Committee will meet next week to decide whether to change its one-day repurchase rate, now set at 3.5%.

A regulatory change on Monday allowing foreign investors to borrow baht locally to settle offshore hedging positions had not affected exchange rates, Dr Tarisa added. Finance Minister Chalongphob Sussangkarn said the appreciating baht had affected the price competitiveness of local exporters, but had also helped reduce the debt burden of companies with foreign loan obligations.

"You need to consider the overall picture, not just the impact on exporters. We don't want to see exchange rates move quickly, but we need to allow rates move in line with market forces," he said.

Dr Chalongphob said that Thailand and other Asian countries were attracting capital inflows as investors shifted out of dollar-denominated assets. Rising investments by government agencies would help ease pressure on the baht over the next several months.