Thailand's economic outlook

Hardest hit will be the grassroots

The state of Thailand's economy appears rather worrisome and the near-term prospects do not look promising. The following is the first of a three-part article on the major economic problems and weaknesses

By CHET CHAOVISIDHA
Bangkok Post, 7-9 June 2007

On the face of it, the current situation pertaining to the economy of Thailand is not as severe as the 1997 financial meltdown and the economic collapse that followed. But the present predicament seems to be wider in scope. Why? Because in the 1997 crisis the real, financial and external sectors collapsed or were near collapse, and yet the public sector was reasonably strong and able to come to the rescue, pulling the whole economy back up on its feet, albeit with the financial assistance of a certain international financial institution. This time, all four sectors are simultaneously plagued with their own particular ills, some more serious than others, although the degree of severity in each individual sector may not be as great as those associated with the three troubled sectors in the previous 1997 crisis; yet some problems appear to be policy-resistant in nature (as will be elucidated).

Nevertheless, the situation has given rise to a great deal of concern, as it has already begun to affect the livelihood of a large portion of the Thai citizenry.

Of major significance is the political instability, manifest by incidents of rallies and protest demonstrations staged by various political and economically-affected groups, and the constant shaping of public opinion abroad against the present administration.

These destabilising activities undoubtedly contribute to the undermining of business and the general public's confidence. They give rise to the concomitant loss of investment incentives, which lead to deferrment of planned direct investment by foreign and domestic investors alike.

Adding to this, the impending general election, tentatively to be held at the end of the year, will bring with it probable changes in economic policy. The unknown factor, combined with the present government's misfiring of several policy actions, represents uncertainty and business risks which would prompt astute investors to put their long-term investment decisions on hold, at least for the time being.

Consequently, only a portion of replacement investment is being undertaken, along with the continuing investment committed earlier.

In the real sector, we are confronted with a number of difficulties. The farm sector is stricken with declining income and a corresponding fall in spending. In addition, it is saddled with a huge amount of household debt, a legacy from the consumption-driven growth policy of the previous administration which relied primarily on debt-creation, geared towards the farm sector and the lower middle class.

The platform was supported by government-owned banks and financial institutions in the form of debt-suspension, liberal lending and policy loans. It has led to the present situation, in which members of the farm sector are clamouring for higher prices for their produce, not only to cover their cost of production but also the burden of interest servicing and repayment of outstanding debts.

The previous government's free-spending and giveaway policy might have been appropriate at the beginning, during which time the economy required an exceptionally strong stimulative policy package to get it back on its feet. Unfortunately, overdoing it by continuing to pursue consumption-driven expansion in economic activities over the next several years of its tenure is the main reason for the farm sector's potential collapse of personal finance. And this will happen soon, as is generally expected, unless proper remedial policy actions are applied in time _ a task which, short of a vigorous support from the public sector's financial resources, cannot be accomplished simply by relying on income generated by current market-determined prices of farm products alone. On top of this, a number of local farm products have succumbed to intense competition from foreign farm imports, to the further detriment of farm income and spending and general economic activities in the farm sector. Saddled with huge debts coupled with declining earnings and slim prospects of future improvement in the economic conditions, the local farm sector will inevitably suffer severe economic hardship.

Aside from this, an increasing number of farm communities has been brought down to earth. They are becoming disillusioned; the realisation has gradually sunk in that they are being reduced to a poverty-stricken and debt-ridden class, in the wake of the departure of the previous administration along with its populist, giveaway policies. They are becoming distraught. All these factors can be seen as a potential incubator for widespread social unrest and political discontent, as already evidenced by the mounting incidence of protests by various local agriculture-related groups _ which can only add to foreign as well as local investment jitters.

The collateral damage associated with household debt has to do with salaried workers in the non-farm sectors, many of whom had previously overextended themselves financially by excessive borrowing and lavish spending.

This bad habit was made possible by the increasingly widespread use of bank and non-bank credit card facilities _ the number of credit cards jumped from 1.6 million to 8.2 million between 2000 and 2005 and to over 10 million in 2007.

These individuals are compelled to languish under constant pressure to meet their monthly interest servicing and partial loan repayments on time. The offshoot is that their workplace productivity and their employers' business performance suffers.

Some household debtors have turned to refinancing their outstanding debts by resorting to new sources of funds, usually at more restrictive terms. This practice is generally deemed undesirable and unsustainable, as there are limited sources of finance available and once these have become exhausted, refinancing must come to an end and the process will reverse itself, with legal proceedings and bankruptcies following suit.

In the manufacturing sector, numerous business units, especially the small and medium-sized, have already felt the impact of the declining overall economic activity and a sizeable number have gone belly up. Many more are expected to follow suit.

Only the large-scale industrial and commercial enterprises have so far managed to endure the currently unfavourable economic conditions and withstand the onslaught of foreign competition.

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OPINION / THAILAND'S ECONOMIC PROBLEMS _ PART II

The trouble with the strong baht phenomenon

This second of a three-part article on the Thai economy deals with the troubles in the financial system and the effects of a strong baht

By CHET CHAOVISIDHA
Bangkok Post, 7-9 June 2007

Continuing from the first instalment on the state of the Thai economy published yesterday, we carry on with our investigation of the causes for the current state of economic malaise: The large-scale industrial and commercial enterprises are primarily supported by their superior technical know-how, strong financial position and more efficient management and operations, in a spirit congruous with the modern, knowledge-based business world.

The local retailing sector has virtually been clobbered by the foreign retailing chainstore giants, as witnessed by the disapperance of countless traditional local mom-and-pop stores all over the country.

While long-term merits and defects of this continuing displacement of the local small shops by the foreign retailing chainstore giants are still being debated, and further evidence is required to substantiate the claim that this situation will eventually lead to a long-term increase in efficiency in the retailing sector as a whole, with net positive benefits ultimately accruing to the economy _ the short-term prospect is quite clear, as evidenced by the loss of business, jobs and livelihood of a substantial proportion of the local retailing community previously engaged in this sector.

The tourism industry is also suffering a setback, as growth in this sector has not met earlier expectations, partly as a consequence of insurgency in the South, arson activities against schools in the Northeast and the threat of sporadic bombings in the central region and the capital.

Besides, this sector has also been most acutely plagued by the ''expansion without employment'' phenomenon, which ascribes expansion in output and income to increased productivity attributed to an advancement in technology and the utlisation of modern, labour-saving machinery and telecommunications equipment, especially in the high-technology service activities.

Hence the past several years have witnessed the expansion in service activities with correspondingly little or much less than a proportionate increase in employment in this sector _ a troublesome tendency, considering that this sector has traditionally been the most progressive and dynamic in its employment-creation capacity and ability to absorb new entrants into the labour force.

On top of all this, the real sector is also inflicted with the so-called ''household debt'' problem. Over the past several years, induced by the previous government's populist policies, household debts have increased tremendously.

On average, they exceed household income earnings by a staggering margin. Since most of these indebted households belong to the lower- and middle-income class and the grassroots echelon of society _ and their income-earning potential is well below the level required to meet their debt obligations _ the situation presents a serious problem for policy-makers.

Why? Because by its nature, this kind of problem becomes increasingly more difficult to deal with under recessionary conditions, as the current economic downturn tends to further aggravate the debtors' situation by putting their job security, income and livelihood at risk.

As an increasing number of households falls into this category, and as their debt burden accumulates with no prospect of improvement of income in sight, they will be likely to start calling upon the authorities to come up with the necessary funds to bail them out.

Unfortunately, such a policy action is unlikely to materialise, on account of the government's precarious fiscal and financial position.

Finally, there is also a genuine concern relating to the long-term growth of the Thai economy.

The growth in GDP is largely attributable to the quantity and quality of labour input and investment or capital accumulation. In the case of Thailand, the investment in new plants and more productive machnery and equipment is the chief contributor to our GDP growth. As reported by a government agency, contribution by a rise in productivity remains rather limited. In this respect, an additional important statistic can give a broader and more relevant perspective: the average rate of economic growth of the past years since 1997 has been consistently below that of the similar interval leading up to the 1997 crisis.

This suggests that the Thai private sector has become more conservative and cautious about over-investing in the same reckless fashion as it did during the years prior to the 1997 crisis.

In this day and age, various countries strive for a high rate of growth and lower cost of production through an increase in productivity. Raise their competitive edge, to be precise. They recognise that the innovation and investment to raise productivity and competitiveness are today's only answer to tomorrow's sustainable growth.

Thailand is an open economy with exports making up roughly 60% of the GDP.

As our competitive edge used to lie in cheap labour, a factor which no longer holds true today, the country's relatively low rate of investment plus slow rise in productivity under the existing, competitive global conditions almost translates to dying a slow economic death. Other emerging countries will soon sweep past Thailand in the economic race to world markets.

The financial sector has, over the past several years, assumed a new complexion in its structure, organisation, and operation.

Since the 1997 financial crisis and the tragedy that followed, a number of local commercial banks and major non-bank financial institutions have fallen into foreign ownership. These foreign majority-owned financial institutions tend to follow modern banking principles and, more often than not, lend on the bases of project feasibility, management ability and good corporate governance, as opposed to traditional banking practices which tend to extend loans to borrowers on the basis of personal relationship and collateral-asset availability.

As a result, the existing financial system is characterised by a situation in which most large-scale enterprises with superior technical know-how, efficient and prudent financial management and operations, a strong financial position and accurate perception of the current and future economic and business outlook, generally find themselves needing less credit from financial institutions. This is despite the latter's willingness to lend to them as they are attracted by their appearance of efficiency and superior performance.

On the contrary, medium- and small-sized business find themselves less able to obtain additional credit for their cash-strapped operations. Potential lenders, with the exception of government-owned financial institutions, look unfavourably on their traditional-style management and operation and are unwilling to extend additional credit, be it asset-based or otherwise.

Another aspect of the financial system is that although technically these foreign majority-owned financial institutions are subject to the same regulation and supervision of the central bank, in practice, they are obligated to attain the objectives and follow the policy guidelines of their overseas parent banks.

Hence the existence of several foreign majority-owned financial institutions signifies a tacit understanding that the existing financial system has become less amenable to the central bank's control. As a result, monetary policy actions have been rendered less effective than previously.

The public sector is currently plagued with a wobbling fiscal position, an inevitable outcome of a weakening economy and declining tax revenues. Additionally, most of the state-owned banks and so-called semi-financial institutions have been seriously weakened by the financial burden imposed upon them by the previous government's free spending and giveaway campaigns.

The upshot is that fiscal policy is subject to a rigid constraint, as a severe limitation has been imposed upon them by the relative scarcity of fiscal and financial resources available.

Inflation has not been a serious threat over the past years, in spite of soaring energy prices and rises in transport and distribution costs. The situation could have been worse had it not been for the working of the strong exchange rate of the baht, which operates to prevent domestic energy prices from going up as high as they could, and would, have. Against the generally unpromising economic backdrop, this could almost be regarded as a bright spot.

Lately though, inflation has begun to rear its ugly head once again. The external sector is at present undergoing a painful experience of the strong-baht phenomenon.

The trouble with the strong baht is that it tends to make for a decline in our exports of goods and services and a rise in imports. This has the effect of depressing our domestic income, production, output and employment.

The reduction, in turn, leads to a fall in consumption and investment expenditure as a result of lower household income and business profitability, thus setting off further rounds of decline in income, production, output, employment, and consumption and investment, until the process finally comes to an end through the income-expenditure interacting mechanism.

This situation has been the outcome of many complex circumstances and an interplay of a host of variables. In the first place, we are being squeezed by a weak dollar as well as a weak yen. Historically, the dollar and the yen moved in opposite directions. As a result, the adverse effect of the former on the performance of our external sector, in terms of exports and imports, was usually and, to a large extent, negated by the latter, and vice versa.

Strangely, the current situation is one in which dollar is weak against the baht and the yen is weak against the dollar and also against the baht. So, conceptually, our exports are supposed to be discouraged while imports encouraged.

Fortunately, Japan's economy has been recovering from its lengthy doldrums. Its increasingly more robust economy has prevented the growth of our exports from decelerating as much as they would have.

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OPINION / THAILAND'S ECONOMIC PROBLEMS _ PART III

Like small fish in a big pond

Thailand will simply have to do its best to cope with a difficult situation, brought about by the actions of major players on the economic scene like China, Japan and the United States

By CHET CHAOVISIDHA
Bangkok Post, 7-9 June 2007

After the 1997 global financial conflagration, several countries have become fearful of the spectre of another financial meltdown _ memories of the pain and hardship their economies went through during that time remain vivid. Understandably, since then most countries have been accumulating foreign exchange reserves with almost reckless abandon. China, in particular, has amassed foreign exchange reserves to the tune of over US$1 trillion.

Such an exorbitant amount of dollars in the hands of a single country _ and many more with substantial amounts in their foreign reserve portfolios _ naturally makes every other country with substantial dollar holdings jittery.

They realise that sooner or later China, faced with the continued prospect of further increases in foreign exchange reserves over the next few years, will relinquish part of these reserves and invest them in other forms of income-earning assets abroad (China actually has already done so recently, though on a relatively small scale) instead of keeping them in non-earning assets at its central bank.

When that occurs, especially on a substantial scale, these other countries will be faced with potentially huge losses on their own dollar holdings.

Thus various dollar-holders are impelled to diversify, or to be ready to diversify, their foreign reserve portfolios into overseas real and financial investment.

Also, they must always be on the alert for potential dollar-unloading action by other foreign dollar holders. This set of circumstances will exert a continuing downward pressure on the dollar to remain weak, so long as the above conditions remain intact.

Additional complications arise because even though Thailand's physical volume and dollar values of exports have increased, the nominal baht values have decreased, a consequence of conversion from the weak dollar to strong domestic currency. The upshot is that a certain proportion of local exporters and producers suffer a fall in profits and others have actually incurred losses. This will invariably trigger off a depressive effect on our economy through an income-induced decline in investment and consumption spending, eventually giving rise to a negative effect on employment, especially in the export and industrial sectors in the longer run.

The strong baht can be expected to stay with us for some time to come. The United States' continuing trade and current account deficits and weak dollar, its sluggish economy, struggling automobile industry and slumping property development and housing activities will continue to exert a contractionary influence on the United States' demand for Thai exports.

This condition normally should have served to weaken the baht but that has not happened because it is more than counter-balanced by more telling influences which pull the baht in the upward direction, as outlined earlier.

Furthermore, the yen is also likely to remain weak as Japan continues to pour a huge volume of investment into China and proceeds to import products thus produced in China as well as other Chinese-produced merchandise for Japan's domestic consumers.

As the Japan-China trade volume has been surging continuously over time and is expected to outstrip the Japan-United States transactions soon, it works to the advantage of the Japanese private sector to maintain a weak yen because under such a circumstance its exports to both the United States and China will keep expanding.

Since expectation is generally self-realising, predictably the self-serving actions of Japan's private sector will continue to keep the yen weak for the foreseeable future.

The conclusion here is that a persistently weak dollar and a comparatively even weaker yen will continue to bode ill for Thailand's external balance sheet and income statement, and make for a sustained strong baht.

There is also a further disturbing prospect for the baht, which is associated with oil money.

The high and rising price of crude over the past few years has flushed the oil-producing and exporting countries with an enormous amount of cash. The Gulf states have spent close to US$1 trillion on investment projects at home and have been shopping around for the best bargains and mopping up assets in the United States, their primary investment destination.

Now they are looking to further diversify their portfilios in the European Community markets and emerging markets in the Southeast Asian region.

In the process, some portion of this money will likely find its way into the hands of the hedge funds and other financial institutions which are well known for their perceived investment skills and speculative expertise, and which are always looking out for opportunities to make profits in any kind of market conditions.

To them the emerging markets in Southeast Asia present an opportunity that cannot be passed up _ most of these countries have attained relatively high rates of economic growth in recent years, with strong foreign reserve positions built up after the recovery from the 1997 financial crisis.

These countries boast securities markets with relatively small market capitalisations, as well as relatively unrestricted foreign exchange market transactions _ a condition which can be influenced by the hedge funds and the like, to secure financial gain. Their operation needs to be more subtle these days though, as they have to make allowance for the spontaneous corrective adjustment inherent in the flexible exchange rate system now practised by most of these countries.

The combination of direct investment from the Middle East oil-rich states and financial investment and speculation by international institutional investors is expected to, in the main, further strengthen the baht and, in the process, create more volatility and wider amplitude of fluctuations in the foreign exchange market.

As long as crude prices stay high, this scenario will endure and the foreign cash inflow will intensify.

For the time being, the oil cash and oil cash-related inflows have been going on in trickles. When this inflow will hit us on a massive scale, with either investment or speculative motives, and how detrimental it will be to the Thai economy, remains to be seen. Meanwhile, we should be making plans to cope with this possible eventuality.

If one has to rank these weaknesses and problems according to their severity and intractability, the top three on the list would be the ''household debts'', ''strong baht'' and ''slow improvement in productivity in the agricultural and industrial sectors'', though not necessarily in that order.

The reason is that although the impact of each factor on the economy is different, all these factors possess important common characteristics with respect to policy actions.

The first two are relatively unamenable to corrective policy actions. In one case, the potentially effective remedial measure is constrained by insufficient fiscal and financial resources available, and the other is subject to an interplay of external circumstances, predominantly uncontrollable by us.

As for the third, it is a long-term imbalance which has to do with scores of structural and institutional factors, needing changes and reforms, such as improvement in education, logistics, communication, transportation, port facilities, beaureaucratic machinery, etc. In effect, these problems and imbalances are likely to persist over time.

And Thailand will just have to do its best to cope with such a difficult situation.

The Constitution Tribunal's recent verdict may have served to clear up political uncertainty and curb the perception of economic risks to a certain extent. Still, the basic economic weaknesses and problems remain and demand effective policy actions.

Chet Chaovisidha is an economist, a former MP for Bangkok, and an economics adviser to several past governments.