CAUGHT IN THE CROSSFIRE

When reports surfaced of a military coup in Thailand in September last year, the relief was palpable when it emerged that no blood had been shed in the process. Just a few months later, however, it was clear that there would be casualties after all – not, as might have been expected, on the streets of Bangkok, but, rather, on its stock exchange.

In December, in a move designed to stem currency speculation by foreigners that had pushed the Baht to a nine-year high against the dollar, the Bank of Thailand (Thailand's central bank) announced new capital controls. Among these was a 30 percent withholding tax to be levied on foreign capital inflows into the country. The move certainly had an impact, but far from the one intended: the Thai bourse registered its biggest ever one-day fall as investors bolted for the exits, in the process severely denting the credibility of the new regime.

Entangled in the fiasco was the listed Thailand Equity Fund (TEF), a $245 million private equity vehicle launched in 2002 by San Francisco-headquartered Lombard Investments and Thai mutual fund company MFC Asset Management. The fund had been attempting to raise an additional 1 billion baht ($25 million) from its existing investors by January this year.

While 400 million baht was secured from domestic investors, which comprised 40 percent of the fund's investor base, the 600 million baht sought from overseas-based investors (comprising 60 percent) was put on hold when the introduction of the capital controls was announced. This latter group of investors includes the International Financial Corporation (IFC), the Asian Development Bank and the California Public Employees Retirement System (CalPERS).

Having been plunged into uncertainty for several months, fundraising for TEF was put back on track in March 2007 when the Bank of Thailand agreed to waive the withholding tax for non-resident investors in the fund. The fund had previously written to the central bank asking for an exemption on the grounds that TEF “has nothing to do with currency speculation” and is “a long-term fund that will strengthen the Thai capital market overall” (the fund has a stated desire to achieve stock market listings for the private companies it backs, with the Thai bourse a possible recipient).

The concession, though undoubtedly welcome, was no great surprise. Ever since the embarrassing stock market slump, the new Thai government had been looking for ways to redeem itself and had sought to do so by gradually lifting the controls. However, the emphasis here is on the word ‘gradually’. That very word was used in an interview central bank governor Tarisa Watanagase gave to Thai business daily Krungthep Turakij in early March: “The Bank of Thailand is waiting for the right time to lift the capital control measure but we have to lift it gradually because the 30 percent reserve requirement still has a psychological impact” that dampens speculation in the Thai currency, she said.

While acknowledging the havoc wreaked by the capital controls, the Thai authorities still appear to believe introducing them was, in principle at least, the right thing to do. Nor is that the only contradiction they appear to be guilty of. In the case of TEF, while the fund's non-resident investors have been assured verbally they are exempt from the withholding tax, the fund must still jump through the bureaucratic hoop of getting approval from the Bank of Thailand for each individual commitment from an overseas source. On the face of it, it's easy to view this as an unnecessary and time-consuming demand.

The military coup and the subsequent knee-jerk reaction of Thailand's legislators to currency volatility have, however, proved a useful reminder of why Asian private equity still needs to deliver a premium over the more established markets of the West.

Such frustrations will not ultimately derail the progress of the TEF fundraising any more than they will dissuade private equity groups generally from viewing opportunities in Thailand with continuing interest. In the face of challenge, the asset class is, after all, normally a dept at demonstrating its resilience. Certainly this is the conclusion you would draw from reports that Lombard and MFC are busy planning a successor fund to TEF, while MFC also has plans for new property- and energy-focused vehicles.

The military coup and the subsequent knee-jerk reaction of Thailand's legislators to currency volatility have, however, proved a useful reminder of why Asian private equity still needs to deliver a premium over the more established markets of the West. Risk has always been – and still remains – a constant companion for investors in this part of the world.