SINGAPORE, March 3 (Reuters) - The Thai baht THB=TH weakened sharply in offshore trading on Monday to converge with its onshore value after capital controls were lifted, but traders said a few remaining limits on flows would stop the two markets merging completely.
Traders also said the Bank of Thailand was buying dollars to keep the onshore rate THB=TH at 31.50 per dollar, not far from Friday's close.
In the less liquid offshore market, the baht THB=W declined more than 4 percent to 31.5/6 per dollar, matching the onshore rate.
"Perhaps offshore traders think they've gone far enough and onshore dollar will now slip towards it. Really, it's only a few pips," said Sean Callow, a strategist at Westpac Bank.
"The BOT is smoothing the way down, but the direction is not in question."
Still, traders said, there were hardly any deals being done involving both onshore and offshore segments.
Bank of Thailand Governor Tarisa Watanagase announced the removal of the controls on Friday, with effect from March 3.
They were imposed in December 2006 to check speculation on a rising baht, with heavy restrictions on how much money foreigners could bring into the country and a minimum period for most investments.
Those restrictions -- including a requirement that 30 percent of any transaction not related to trade or direct investment be left interest-free with the central bank -- created the two-tier baht market.
The spread between the two markets was as wide as 4 to 5 baht in mid-2007, but it narrowed gradually to as low as 0.9 baht last week as investors positioned for an imminent lifting of the controls.
Thailand elected a new government in December, restoring civilian rule following a military coup in September 2006.
SOME CONTROLS REMAIN
The baht was was Asia's top performer against the dollar in 2006 with a gain of 14 percent and the onshore baht gained 7 percent against the dollar in 2007.
While announcing the removal of capital controls, Tarisa also said the authorities had alternative measures to stabilise the baht.
For instance, the amount onshore players could borrow from non-residents was cut down, and the amount onshore players could lend to non-residents was increased six times.
"Divergences may still occur, such as offshore dollar/baht to trade significantly below onshore if dollar borrowing costs make funding onshore more expensive," Claudio Piron of JPMorgan Chase said.
"This expense is transferred to the non-resident party with a more expensive offshore baht spot rate."
The central bank also said the country would allow Thai companies to invest more offshore.
That seemed to indicate the central bank would keep a tight rein on the baht, bearing in mind the interests of Thai exporters, even if it has opened the doors once again to speculators and short-term investors.
Moreover, some economists expect the tide will turn against the baht as the arrival of the new democratic government boosts consumer and business sentiment and therefore spending on imports.
"Removal of capital controls may result in further appreciation in the exchange rate in the near term and reduce the gap between the onshore and offshore rate," Morgan Stanley economist Chetan Ahya said in a note.
"However, we believe that over the next 4-6 months, higher domestic demand and higher imports should reduce the trade surplus significantly, helping the central bank manage exchange rate stability better." (Reporting by Vidya Ranganathan; Editing by Alan Raybould)