The Monetary Policy Committee (MPC) may defy pressure for an interest rate cut if the state of the economy does not warrant it to maintain the credibility of monetary policy, says Prasarn Trairatvorakul, governor of the Bank of Thailand.
The local bond market has been the major recipient of foreign capital inflows from January to April this year, totalling US$4.84 billion compared with $9.2 billion throughout last year.
Mr Prasarn said investors' expectations of capital gains from local bonds are the key factor attracting foreign funds rather than interest rate gains.
The MPC has underpinned its interest rate decision on the local economy, not external factors, he said.
"Admittedly, the policy interest rate is a tool to address capital inflows, but there are many factors affecting them. As well, the role of the policy interest rate is to maintain local equilibrium," said Mr Prasarn.
He said the central bank's failure to maintain credibility in the eyes of markets could push up the government's borrowing cost for the 2-trillion-baht infrastructure project.
"The financial market currently has confidence in our monetary discipline, reflected in a yield of 4.27% for 48-year government bonds. The lack of it could push up inflation expectation and long-term yields," Mr Prasarn said.
"A change in the interest rate must be justified."
The MPC cited too rapid expansion of the property sector and lending growth as reasons to hold steady the policy interest rate at 2.75% at the previous meeting on April 3 although it said inflation was benign.
Mr Prasarn said the MPC will have a better insight into the economy when the first-quarter gross domestic product data are released before its next meeting on May 29.
The MPC has pledged to implement a "policy mix" to look after foreign capital inflows.
He said the central bank worries about the impact on the economy from the reversal of capital flows if the US and Europe recover and unwind their money-pumping measures.
"Think of the 1996-97 economic crisis. Investors fled the country, and the baht plummeted to 56 to the US dollar from 25. No one would have dreamed that 15 years later, everyone is eyeing baht-denominated assets. This too could happen to the dollar, euro and yen. I hope the economy does not swing back to 1997," Mr Prasarn said.
He said hedging is the strongest measure of all to curb inflows, as it removes any profit investors can make from currency appreciation.
Other measures it reportedly submitted to the cabinet to control the inflows are setting the minimum period for foreigners' holding of government bonds, prohibiting their access to central bank's bonds and levying fees on offshore investors profiting from bond investment.
He said foreign exchange intervention is among its tools to tame the baht's rise.
Mr Prasarn said the objective of monetary policy is to allow the economy to grow based on its potential rather than boosting it artificially.
The foreign exchange market, however, does not expect the central bank to implement capital flows management measures any time soon, as the baht retreated to below 29 to the dollar from a peak of 28.50 last month.
Deputy Prime Minister and Finance Minister Kittiratt Na-Ranong said he has asked to meet on Monday with MPC members and representatives from the private sector to exchange views.
He again criticised the policy rate-setting committee, saying it should take into account not only inflation but also the monetary easing measures adopted by central banks of advanced economies.
The MPC must simultaneously set a target in managing foreign exchange rates, said Mr Kittiratt.
Arkhom Termpittayapaisith, secretary-general of the National Economic and Social Development Board, said the weak first-quarter economic data reflect a slight effect from the baht appreciation and the stimulus measures in the US, Japan and the euro zone.