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Thailand’s domestic bond markets have shown a peculiar resilience despite the kingdom’s political situation being in a constant state of flux. The baht bond market has stayed liquid no matter how volatile markets have been, thanks in no small part to active participation from Thai retail investors.
Now, with elections just a month away, the country has started marketing an inflation-linked bond. The debut linker is part of an ambitious plan that will make Thailand the first country to establish an inflation-linked market in Southeast Asia.
The country plans to offer up to Bt40 billion ($1.3 billion) of 10-year inflation-linked bonds to Thai retail and institutional investors. Thailand will also market the deal to foreign investors during a second roadshow — said to be conducted in Singapore, Hong Kong and London in the third week of June.
The bond is set to price early July, shortly after millions of Thai citizens cast their votes on July 3. Thailand continues to be a nation deeply divided and in the upcoming elections, the Democrat Party, led by Oxford-educated prime minister Abhisit Vejjajiva, will come up against Puea Thai, a party that is loyal to former prime minister Thaksin Shinawatra, who was ousted in a military coup in 2006.
HSBC, Kasikornbank, KrungThai Bank and Siam Commercial Bank are the arrangers for the bond. Previously, two foreign banks — Deutsche Bank and Standard Chartered — were working on the structure of the bond and were part of the original consortium together with the three Thai banks, but were later ousted by HSBC. According to one source, HSBC showed the Thai government a structure that was 50bp tighter in pricing and managed to wrest the deal away.
Thailand’s inflation-linked bond — also known as a capital-indexed bond or linker — is expected to pay a coupon of 1% to 1.2%, with the exact rate to be determined through a bookbuild that will take place in July.
The bond is being marketed at a time when rising inflation has stirred a chord of discontent among citizens. In this respect, Thailand’s government could well learn from Singapore — where the ruling People’s Action Party found itself with the lowest approval rating ever since coming into power as a large proportion of voters were disgruntled with the high cost of living. Thailand’s headline inflation soared to 4.2% in May.
The structure of the bonds is similar to Treasury Inflation Protected Securities (Tips) in the US. The underlying principal of the bond will be adjusted depending on the prevailing Thai consumer price index (CPI). The principal of the bond increases with inflation and decreases with deflation, and the fixed rate is applied to the adjusted principal.
For example, if the coupon is fixed at 1% and inflation rises 3% during the first year, the principal would rise to 103 and the interest paid out would rise from $1 to $1.03. In the unlikely event that there is 4% deflation in Thailand during the second year, the principal would then fall to 99 and the interest payment would fall to $0.99.
The principal is protected at maturity — so an investor will be repaid the original principal or the adjusted principal, depending on whichever is higher. An investor can work out the return of the bond based on the expected inflation rate during the next 10 years.
Based on investor feedback, there is interest in the product but foreign investors are concerned about liquidity and some of the finer details.
“There are some nitty-gritty issues to be addressed, such as how the bonds are taxed and whether there will be a capital gains tax if the principal of the bond goes up,” said one Singapore-based investor.
To stem the baht’s rapid appreciation, Thailand late last year reintroduced a 15% withholding tax for foreign investors’ holdings in government bonds. According to one source close to the deal, the linker will be treated similarly to Thai government bonds and there will be a capital gains tax of 10% to 15% for foreign investors depending on the double tax treaty of the investor’s resident country with Thailand.
Then, there is the issue of liquidity, which has proven challenging in mature linkers markets. “In places such as the US, France and Korea, inflation-linked bonds were initially quite illiquid and our experience with Korean linkers has been that they continue to be illiquid,” added the Singapore-based investor. “Getting a product like a linker off the ground in any market is challenging,” he added.
A big part of that challenge is that the natural buyers of inflation protection tend to be buy-and-hold investors.
“Based on feedback from local investors, we understand that the inflation-linked bond is targeting long term funds — including pension funds, provident funds as well as Thai retail investors,” said one Bangkok-based banker away from the deal. “So we don’t know how liquid it will be.”
The four selling agents — HSBC, Kasikornbank, KrungThai Bank and Siam Commercial Bank — will act as market makers for the bond.
