Stronger medicine needed to curb the rise of the baht
The baht yesterday broke the Bt35/US dollar level to hit Bt34.99 for the first time in nine years, as exporters rushed to convert dollars into baht.
This happened even before Dr Chalongphob Sussangkarn, the finance minister, was able to meet Tarisa Watanagase, the Bank of Thailand governor, to discuss the currency crisis and macro-economic direction.
Chalongphob faces a tough test over how to halt the rise of the baht, which is harming the competitiveness of Thai exports. One major rice trader has complained that if the baht were to go up to Bt32/dollar, he would no longer be able to compete in the world market. But already the offshore baht is trading at Bt32-Bt33.
A stronger baht is not good for importers either. A jewellery trader has complained that importers have bought materials from overseas at Bt36-Bt38/dollar and will now stand to lose money if they have to sell their goods at Bt35/dollar. A financial executive has told me that Thai businesses have been operating at near capacity for several years and have yet to upgrade their equipment through new investment. Without new investment, they will soon not be able to compete with neighbouring countries. But even if they were to invest in new machinery and equipment, would they be able to compete with China or Vietnam? And what will happen if the baht keeps on rising like this?
The financial markets are also monitoring Chalongphob's view on interest rates. There are now three schools of thought on Thai interest rates. The Finance Ministry's Fiscal Policy Office has suggested a radical policy, calling for bank authorities to cut the policy rate outright by one full percentage point to save the economy and to deter baht appreciation. This comes at a time when domestic demand is getting weak, credit growth is slower, inflation is increasing and money supply growth is falling.
A report by HSBC Global Research (March 14, 2007) has urged the banking authorities to adopt a middle path by raising the policy rate by 50 basis points at the next meeting of the Monetary Policy Committee on April 11. But eventually, the banking authorities will have no choice but to cut rates steeply this year in order to cushion the weakening economy. We can see the policy rate going down to 3.50 per cent this year, according to HSBC Global Research.
A report by CitiGroup Global Markets (March 13, 2007) has advocated an incremental policy - the stance the authorities are now taking - by calling for the rate to be cut by 25 basis points at a time. After the banking authorities have cut the rate by another 25 basis points to a cumulative 50 basis points, then they can re-evaluate to see whether they are on track in inflation targeting.
We are not sure which school of thought Chalongphob belongs to when it comes to interest-rate policy. However, he has the daunting task of salvaging the economy. There is a big risk that the Thai growth rate might slip below 4 per cent this year. Still, the government is projecting a growth rate of between 4.2 and 4.5 per cent, banking on fiscal stimulus to come to the rescue, although government spending is always slow to come, due to red tape.
A regional analyst from Hong Kong is not happy with the Thai situation, telling me the government should admit that the economy is going to be weak this year. Instead of projecting an ambitious and unrealistic growth rate, the government should revise the figure down and work on a new lower target, he said. If it fails to achieve the forecast, the interim government would face another credibility problem, he added.
The situation looks funny now. While we are facing a weak economy, the currency keeps on climbing. But this can be explained by strong external demand, which is the main driver of the Thai economy at the moment. The baht has become stronger, not because of portfolio inflows but because exporters are converting their surplus dollars into baht.
Fresh after his appointment as finance minister, Chalongphob, who has spent most of his career as an academic, might not want to rock the boat. There was no exciting news emanating from his meeting with Tarisa yesterday. First, Chalongphob will not interfere with the Bank of Thailand's affairs. Second, the capital controls will be maintained, depending on the further judgement of the banking authorities. Finally, the central bank will have full independence to manage its interest rate policy. Let's see how the Monetary Policy Committee will act at its April 11 meeting. Already, financial markets are speculating the central bank will cut the rate and remove the 30-per-cent reserve requirement, which has already been rendered obsolete anyway.
But the bigger question remains unchanged: How can Thailand move up the value-added chain in its economic development? Cutting rates deeply and removing capital controls only represent a small step ahead. Standard & Poor's ("East Asian Reserves Are Squeezing Out Monetary Options", Jan 29, 2007) foresaw a constraint on East Asian countries' capacity to intervene in foreign exchange markets to halt a rise in their currencies. Monetary policymaking has got complicated. Some central banks have lost heavily on the marginal holdings of their foreign exchange reserves. The Bank of Thailand has lost Bt300 billion alone from its foreign exchange interventions, including the cost of issuing bonds to sterilise liquidity from its monetary injections.
Standard & Poor's recommends that in the medium term, governments, including Thailand, ease constraints on monetary flexibility by introducing greater domestic competition in the non-trade sector, liberalising business regulations and promoting deeper domestic capital markets. So, we're back to the same question: how to improve the competitiveness of the country as a whole.