- Thailand's economy grew at 4.8 percent in 2007. Despite a number of factors affecting public sentiment - the political uncertainties, the imposition of capital controls in December 2006 (subsequently removed in March 2008), and the proposed amendments to the Foreign Business Act - net exports continued to provide the main support for growth while domestic demand has continued to remain weak. The Thai economy is expected to slow slightly in the second half of 2008, and then pick up speed again in 2009 as long as global energy prices continue to fall back somewhat from their June 2008 highs.
- Headline inflation had been on a downward path after peaking in mid-2006, but started to pick up in Q4 2007 on the back of escalating energy prices, and reached an annual rate of 9.2 percent in July. Core inflation has been lower, but has followed a similar trajectory, reaching 3.7 percent in July and thus falling just outside the Bank of Thailand's 0-3½ percent target band. The Bank of Thailand has, belatedly, begun a process of monetary tightening, but we do not anticipate they will move into truly “hawkish” mode.
- Following an appreciation of about 14 percent against the U.S. dollar in 2006, the baht appreciated by a more moderate 6.4 percent in 2007, in line with other regional currencies. The current account registered a surplus of over 6 percent of GDP, and reserves increased to US$87½ billion by end-2007 (equivalent to 6½ months of imports of goods and services). This appreciation has continued into 2008, and given the importance of exports to the Thai economy it is likely that restraining any further significant rise will be an important objective shaping policy formation both at the central bank and at the Ministry of Finance.
As is to be expected, both the cyclical and the structural performance of Thailand’s economy tend to be somewhat adversly affected by the various comings and goings associated with the country’s ongoing internal political conflicts. Historically the political instability which these create has tended to manifested itself in the form of what are admitedly normally rather benign military coups. Although a strong argument could be made that these specifically Thai political theatricals have already been incorporated into market pricing and practice it is still a factor which investors need to bear in mind, as capital flows may, on occasion, be temporarily affected.
In our most recent long term analysis of the Thai economy (see Thailand’s Economy – At a Crossroads) we showed how GDP growth in 2006 was almost exclusively driven by net exports as household consumption and fixed capital formation came grinding to a halt. A key internal development to take into account here has been the military coup and ensuing economic uncertainty which lingered throughout 2006 and which naturally put a significant lid on domestic activity.
In 2007 the positive contribution from net exports remained the core component in GDP growth but there has also been a clear change in the underlying tempo. Domestic demand was on the upswing in the second half of last year with private consumption expenditure up by a moderate 1.8 percent y-o-y in each quarter, following a very lacklustre performance indeed in each of the previous two quarters. This tendency was sustained into Q1 2008, with private consumption up by a much more solid 2 pedrcent y-o-y.
Agricultural output has, as might be expected given the surge in global prices, grown considerably, and was up by 3.5 per cent year-on-year in the first quarter, accelerating slightly from 3.1 per cent in the previous quarter. Both livestock and crop production increased significantly, and particularly the production of rice and energy crops such as cassava, palm oil and soybean. High agricultural price evidently encouraged farmers to expand their production. Growth in manufacturing output remained healthy, and was up 9.7 percent year-on-year, as compared to an average growth rate of 5.7 per cent in 2007. This surge in manufacturing was driven by both export-oriented and domestic-oriented industries. Export-oriented industries which put in a strong showing included electronic products, computers and equipment, televisions and air conditioners, while domestic-oriented industries such as the production of alternative energy (E20) compatible cars and petroleum products also expanded well.
Private investment was up a healthy 6.5 percent year-on-year in Q1, largely accelerating on the back of increased machinery and equipment investment from the previous quarter’s growth rate of 3.9 percent. Previous baht appreciation helped cap import costs, while at the same time attracting the capital to replace and expand plant and equipment. Business confidence also improved in Q1, and the Business Sentiment Index rose from 45.0 in the previous quarter to 45.9. Investment in construction also began to recover, following a sharp contraction in Q4 2007.
Finally, and after a predictable slump in 2006 on the back of the political tensions and the aftermath of the Tsunami tourism, has continued to accelerate in 2008 and preliminary data for Q2 show an improving trend, partly due to a low base in the same period last year, and the number of tourists during the first 2 months of the quarter expanded on average by 16.6 per cent year-on-year.
On the external front, net exports in Q1 contributed 0.6 per cent to GDP, down from the 2.5 per cent registered in the previous quarter. This was mainly due to a rise in imports following an expansion in domestic demand, and of course the increased cost of oil. Imports were up by 10.3 per cent year-on-year in Q1 accelerating across the board in every category from 6.2 per cent growth in the previous quarter. Meanwhile, exports of goods and services continued to expand well with a growth rate of 8.7 per cent year-on-year. Noticeably, income from foreign tourists rose sharply while exports of goods softened slightly compared to the previous quarter. This was due to a softer growth of exports in fisheries and electronic circuits, despite healthy export growth in agricultural products, jewelry, vehicles and parts, and electrical appliances.
For 2008, the central bank is forecasting GDP to be in the range of 4.8% to 5.8%, while Thailand's Finance Minister Surapong Suebwonglee is predicting 6%. Since 2007 saw growth at only 4.7% this latter view must be considered a decidedly bullish forecast, and it is more than likely that general global conditions will dictate a rather slower pace of growth in the second half of the year following a strongish showing in the first half.
As regards its external balance Thailand still seems to be laboring under a once bitten twice shy mantle. Thus, with the exception of a rough, but short, bout of capital flight in 2005 Thailand has maintained a small but clear surplus on its external books. Given Thailand’s economic development profile this may seem rather odd but the effects of the Asian currency crisis still clearly in the forefront of Thai policy makers thinking.
This surplus has been achieved through continuous attempts by the Thail authorities, not to halt capital outflows, but rather to slow down inflows and the ensuing appreciation of the Bhat. Consequently, in December 2006 the BOT put in place capital controls and demanded unremunerated reserve requirements (URR) on short term capital inflows in order to deter speculation over possible appreciation of the Bhat. Capital controls were finally lifted in November 2007 and the reserve requirements disappeared at the end of February 2008.
However, and even though Thailand has been rather cautiously dipping its toe into the water with respect to a full blown exposure to the global search for yield, the post 1998 currency crisis economy has still seen a steady flow of foreign investors moving into Thailand (see here Thailand’s Economy – At a Crossroads).
This leads us neatly to the break-up of the current external position. In light of a consistent positive financial account and thus inflow of portfolio investments Thailand’s income balance is, as might be expected, negative. This is perfectly in line with economic fundamentals as it merely means that foreigners hold more claims on Thailand than Thailand holds on foreigners.
In fact, as the GDP break down above shows, this persistent surplus on the external balance is what propelled Thai GDP growth throughout 2006 and to some extent into 2007, although domestic demand is now picking up, even though the rate of acceleration is slow.
Moving on to price developments, Thailand enjoyed something of a perfect storm in 2007 as headline inflation remained pretty subdued at 2.3% (y-o-y) with core inflation running at around 1%. This was well in line with the central bank’s, rather wide, core inflation target which lies in the 0-3.5% band.
However, a target this wide which is based on core prices does not seem an especially strong or adequate instrument in the current climate. Thus, while headline prices remained relatively low in the first three quarters of 2007, Q4-2007 and Q1-2008 have seen Thailand subjected to the full volley of the global energy and food price inflation shock.
Recent forecasts from the central bank are signalling significant upside risk to future inflation developments. The combination of rising headline inflation feeding into producer prices at one at the same time as domestic demand seems to be staging a recovery points towards further inflation in the pipeline. The quarterly PPI index rose at a significantly higher pace in Q4 2007 (7% y-o-y) and Q1 2008 (10.3% y-o-y) relative to previous quarters. Consequently, in their most recent inflation report the bank does seem to have taken on board the need to take headline inflation into account too . The main argument here is that the latter now seems to be breaking its hitherto strong trend-relationship with core prices.
In light of the increased pressure from headline prices, the central bank (chaired by Mrs.Tarisa Watanagase) opted, at the July meeting, to up interest rates by 25 basis points to 3.50%. This raise broke the 3.25% holding position the bank has maintained since Q3 2007. According to the central banks own 2008 core inflation forecasts (2.2% y-o-y) the 3.5% interest rate translates into a positive real rate of 1.3%. However, if corrected for the current headline inflation the real rate resides firmly in negative territory at -5.7%. In general, and according to the central bank’s own calculations, we can cleary affirm that Thailand’s real interest rate remains one of the lowest among any of its Asian peers.
One key variable to gauge in this context would then also be the Bhat. In light of global fundamentals one would expect a hawkish central bank to coincide with an appreciation of the currency. Given the fact that the BOT has held rates steady for the past 1 ½ year, we are still to see whether this applies in Thailand’s case. So far the appreciation against the USD has seen the Bhat rise in value to the tune of 23.5% (at its peak) since January 2006. The recent months however have seen the USD claw back some of this so that the USD/BHAT now resides in the 33-34 range.
In light of the gradual lifting of reserve requirements and capital controls the outlook on the Bhat has been decisively bullish, with sell side analysts forecasting an appreciation in the region of 15% against other major currencies. In many ways, the Bhat already has been riding an appreciation around these levels and it is unclear that it will move towards 20-25 against the USD anytime soon.
Outlook on Key indicators
GDP growth is expected to remain strong in Q2, and then slow slightly in the second half of the year. However, if we take current prices and deflate with the immediate level of inflation it is not at all unlikely that inflation may eat up a substantial amount (especially if we deflate with headline inflation) of any potential increase in living standards and purcasing power, and private consumption is likely to remain weak, and recent poor showings in consumer confidence would seem to point in this direction. Generally, the slowdown in global momentum should also be put a de-facto ceiling on the current expansion in Thailand’s economy. At the same time, should global oil prices fall back more in the second half of the year, it is our opinion that Thai growth may well accelerate again in 2009, and we are currently forecasting headline GDP growth in the 5.5 – 6 percent range for FY 2009.
In the statement following the recent 25 basis point hike the monetary policy committee (MPC) noted that it would stand ready to counter any effects from further increases in inflation. Given this investors should begin to incorporate the idea of an increasingly hawkish BOT into their thinking. However, it remains unclear whether in fact we are not at a tipping point as far as golbal inflation goes. Should this be confirmed, and should headline inflation finally begin to offer a breathing space, then the BOT may be reluctant to raise rates to any significant extent, especially if this would mean driving up the Bhat further at a time when export growth remains the principle strong point in the economy .
The future course of the Bhat is thus difficult to call at this point in time. Clearly, if the economy continues to expand from its low “post military coup” level, and if the BOT opts for a hawkish course then the scene is set for a significant further appreciation of the Bhat. However, the general outlook for Asian economies is also one of re-coupling to the rest of the world and given that Bhat already is at a fairly high level (e.g. against the USD) we will need to see the BOT’s reaction and investors’ response before making any decisive call on the trend.