Dr. Supavud Saicheua on the economic outlook for Thailand
By Jon Fernquest |
Neither the outlook for the US financial system nor the outlook for Thai politics looks very promising.
Supavud Saicheua, head of research for Phatra Securities, provides an overview of the key factors and unknowns that will either make or break the economy in the near future.
Here is the article in full:
ECONOMIC OUTLOOK
Volatile times ahead for Thailand
SUPAVUD SAICHEUAWednesday July 30, 2008
There is much confusion about how things might develop in Thailand in the coming months. At the risk of being wrong, I have identified three factors that I consider most important.
1. US Subprime Crisis
These are, firstly, problems of US financial institutions which are again in the forefront. Inflation remains a worry for Asia and Thailand. Finally, the unpredictability of Thai politics has made the predictions of fortune-tellers as sought-after as the writings of political commentators. How the US financial sector fares in the coming months will have an important bearing on the global economy. In the summer of 2007, the bursting of the US housing bubble caused financial damage to US banks because of high risk or "subprime" lending. Some thought that the damage would soon be contained, especially after various financial institutions made bold write-offs and aggressively sought new capital.
The generous participation of Sovereign Wealth Funds added to this confidence.
However, the emergency rescue of Bear Stearns in March this year made it clear that the problem has spread into various fixed income and derivative instruments.
The novel ways in which the US Federal Reserve made liquidity widely available to US financial institutions on top of the aggressive cuts in its policy rate from 5.25% to 2.0% meant that the situation was grim.
The latest financial emergency prompted the US Treasury to spearhead the rescue of Fannie Mae and Freddie Mac, two government-sponsored corporations (GSCs) that are too important to fail. The two GSCs guarantee or directly provide mortgage loans worth $5.2 trillion, nearly half the system-wide mortgages worth $12 trillion. They are highly leveraged with capital - only 1-2% of total assets. Such leverage is not a problem under normal circumstances given the perception (though not written in law) that GSCs are backed by the US government.
But with US home prices falling 15% and the prospect of more to come, the US Congress has no choice but to approve legislation that authorises the US Treasury to provide any amount of credit and equity that Fannie and Freddie may need, along with help from the Federal Reserve.
Approving a law authorising a "blank cheque" to rescue Fannie and Freddie has led to optimism that the worst may be over. Such a belief could prove premature.
Merrill Lynch now sees US GDP contracting by 2.5% in the 4Q08 [fourth quarter 2008] and 2.3% in 1Q09 [first quarter 2009]. For all of 2009, Merrill Lynch sees a 0.5% contraction in US GDP, whereas others expect US GDP to expand.
The IMF's latest forecast sees the US economy growing 0.8% in 2009. The IMF considers its forecast "gloomy" because it sees global growth falling from 5.0% in 2007 to 4.1% in 2008 and weaker still to 3.9% in 2009.
Why will things not get better?
Merrill Lynch points out that US financial institutions have tightened credit significantly not just for home mortgages but for commercial mortgages, car loans, credit cards, etc.
Recently, Fannie and Freddie were the main source of additional lending for the system. The rescue of Fannie and Freddie, though dramatic, may not restore its ability to expand credit. Indeed, lending more when home prices continue to fall could prove difficult when it is clear that the bill for damages will have to be paid by US taxpayers.
Moreover, some analysts noted that the severe compression of US asset prices is likely to claim many more casualties, if past financial crises are a guide.
The Savings and Loans crisis of the late 1980s caused 1,500 US financial institutions to go under. The situation stabilised only after the establishment of the Resolution Trust Corporation to buy out and manage down bad assets.
So far, only six US financial institutions have failed, so it is feared that many more could follow suit in the coming months as the US economy heads towards recession.
Accordingly, futures markets now see inflation as less of a problem in developed economies. No US interest rate hike is expected until the yearend, while hopes of rate cuts in Europe are being revived.
The sharp fall in oil prices from $147 to $125 during the past two weeks likely reflects this increased pessimism as much as initiatives by US authorities to investigate speculation.
2. Inflation in Asia
Meanwhile, foreign investors remain concerned about Asian inflation and the inability of our central banks to tighten monetary policy in a timely manner.
In sharp contrast to this, Asian governments and businessmen are more concerned about economic slowdown and therefore central bank tightening has been gradual and reluctantly accepted.
Asia's implicit peg to the US dollar increases the risk that Asians will find runaway inflation the unwelcome surprise for 2009.
US monetary easing risks increasing the dollar price of crude oil and other commodities, setting the global economy up for prolonged inflation, as was the case in the 1970s.
The correlation between the dollar price of crude oil and the dollar-euro exchange rate was 95% from January 2007 to July 2008. If the dollar depreciates to two US dollars to one euro, and if past correlation between oil and dollar/euro holds, the price of oil would be $219-233 per barrel.
[Scenario #1] Asia has been struggling to control inflation since 2007 and the pegging of its currencies to the US dollar increases the risk of inflation getting out of hand in 2009.
[Scenario #2] On the other hand, a US recession is necessarily deflationary. If it is severe and spreads, Asian inflation could be a minor concern in 2009.
But only one of these two scenarios is the correct one. It seems that the majority view favours the first scenario, but a slight shift is now taking place towards the second.
Further sharp reductions in oil prices could forewarn that the second scenario is becoming more likely.
3. Political stability and Thailand's long-term growth
Thailand's political instability means that the country's future growth is being diluted in two main ways.
First is the inability to undertake long-term economic reform and liberalisation. The Constitution Court's decision on Preah Vihear has impaired the country's ability to engage itself in the ongoing globalisation of the world economy.
In general, the government finds it difficult to push forward long-term investment projects because of general distrust and detailed oversight.
Second, any future returns expected from an investment project must be subject to a larger discount rate to reflect the increased risk that elected governments will come and go quickly in Thailand.
It is clear that the 2007 Constitution has many pitfalls and those wanting to amend it are being actively opposed.
Current political difficulties faced by this government means that its remaining lifespan could be measured in a matter of months.
The instinct that new elections may not resolve the underlying conflict is the right one.
The bottom line is that despite its lacklustre performance, the People Power party - or a reincarnation of it - may not see its seats in parliament dwindle. This is because the Democrats are likely to face difficulties in trying to win more seats in the populous North and Northeast.
Smaller parties such as Puea Pandin, Chart Thai and Matchimathipataya are at risk of being dissolved. If not, their lack of success in the last election could make it difficult for them to carry on.
But the return of PPP appears unacceptable to powerful groups in Bangkok. And the mechanics of what Thai academics call "judicial activism" and politics on the streets is likely to shorten the life of any elected government headed by populist leaders.
In conclusion, there is little good news on the horizon. Ironically, the sharper than expected slowdown in the global economy could help bring Asian inflation under control, allowing domestic expansion to offset the shortfall in global demand.
However, Thailand's political quagmire seems far more intractable, opening up downside risks for the Thai economy in a way that is difficult to quantify.
The author is head of research, Phatra Securities Public Co, Ltd.
(Source: Bangkok Post, op-ed section, 30-07-08, temp-link)
Vocabulary:
Monetary Policy and Economics Vocabulary:
subprime lending - home loans in the US made to risky borrowers, many of whom could not make payments after a while, thus causing problems for the banks (See Wikipedia)
US Subprime Crisis - an ongoing economic problem in the global banking system that began with housing loans that people couldn't pay back in the US in late 2006 and triggered a global financial crisis through 2007 and 2008 (See Wikipedia)
a bubble, an economic bubble, a financial bubble, a market bubble - when asset prices rise to unreasonably high levels given true asset values, investors make a lot of money, and are very enthusiastic about the market, then one day asset prices suddenly drop (the crash), investors lose a lot of money as well as their enthusiasm for the market, besides causing market instability, bubbles also have a negative effect on economies because they temporarily misallocate funds into non-optimal uses" and then quickly pull them out (See glossary)
US housing bubble - when prices of houses in the US rose to a very high and unsustainable level
write-offs - the decision by a company that they will never recover what they spent on something (an investment, a loan) so they take the whole loss now, rather than painfully taking it over a long perion in the future, this allows them eventually to start over again
bold write-offs - have the courage to accept that they will never recover what they spent
capital - money invested in a business (See glossary)
aggressively sought new capital - look everywhere for new sources of business funding with great energy
Sovereign Wealth Funds - state-owned investment funds "composed of financial assets such as stocks, bonds, property, precious metals or other financial instruments. Sovereign wealth funds have gained world-wide exposure by investing in several Wall Street financial firms including Citigroup, Morgan Stanley, and Merrill Lynch. These firms needed a cash infusion due to losses resulting from the credit crunch." (See Wikipedia)
Bear Stearns - (See Wikipedia)
fixed income instruments - any type of investment that yields a regular (or fixed) return, such as bonds, pensions, or preferred stock shares (See Wikipedia)
derivative instruments - financial securities whose value is derived from (comes from) that of other securities, includes futures, forwards, options, and swaps (See Wikipedia on derivatives and derivatives markets)
the US Federal Reserve - the US central bank (See Wikipedia)
liquidity - the amount of money, loans, and credit available in an economy to fund businesses and consumer purchases, also how easily an asset can be converted to cash (See Economist glossary)
made liquidity widely available - increased the amount of money, loans, and credit in the economy
highly leveraged with capital - have borrowed a lot of money to finance business operations
tightened credit - very little money and loans available in the economy
Fannie Mae - Federal National Mortgage Association, a GSE, a US government created bank which helps to replenish money for home purchases and loans, the leading market-maker in the U.S. secondary mortgage (home loan) market (See Wikipedia)
Freddie Mac - Federal Home Loan Mortgage Corporation, a GSE similar to Fannie Mae specialising in home loans, "Freddie Mac buys mortgages on the secondary market, pools them, and sells them as mortgage-backed securities to investors on the open market. This secondary mortgage market increases the supply of money available for mortgages lending, and increases the money available for new home purchases" (See Wikipedia)
Government-Sponsored Corporations (GSCs), Government Sponsored Enterprises (GSEs) - a Government Sponsored Enterprise, banks created and supported by the US government, "a group of financial services corporations created by the United States Congress. Their function is to enhance the flow of credit to targeted sectors of the economy and to make those segments of the capital market more efficient and transparent. The desired effect of the GSEs is to enhance the availability and reduce the cost of credit to the targeted borrowing sectors: agriculture, home finance and education.[citation needed] Congress created the first GSE in 1916 with the creation of the Farm Credit System; it initiated GSEs in the home finance segment of the economy with the creation of the Federal Home Loan Banks in 1932; and it targeted education when it chartered Sallie Mae in 1972 (although Congress allowed Sallie Mae to relinquish its government sponsorship and become a fully private institution via legislation in 1995). The residential mortgage borrowing segment is by far the largest of the borrowing segments in which the GSEs operate. Together, the three mortgage finance GSEs (Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks) have several trillion dollars of on-balance sheet assets." (See Wikipedia)
backed by the US government - supported and helped by the US government, if they fail the US government will help them
a blank cheque - permission to spend as much money as you need or want to spend (a signed check without an amount on it, you can put in any amount you like)
severe compression of US asset prices - a large fall in US asset rpices
buy out and manage down bad assets - buy default loans (lender stopped paying back loan) to inject money into the system and get the assets operating in the economy again
initiatives by US authorities to investigate speculation
inability of our central banks to tighten monetary policy in a timely manner - didn't raise interest rates quick enough
central bank tightening - central bank raises interest rates, contracting credit and loans (eventually decreased GDP, money supply, and deflation)
US monetary easing - US central bank lowers interest rates, expanding credit and loans (eventually increased GDP, money supply, and inflation)
runaway - uncontrollable and dangerous, cannot be controlled (for example, the runaway car rolled down the steep hill and hit many pedestrians)
runaway inflation - inflation that cannot be controlled, that keeps increasing
prolonged inflation - inflation that lasts for a long time
deflationary - when prices fall in an economy (opposite of inflation)
reluctantly accepted - accepted, but don't want to accept it
implicit - meaning not stated or expressed directly, implied meaning
Asia's implicit peg to the US dollar - the currencies of Asian economies are tied to and move with the US dollar
diluted - reduced, made less strong (than it could be)
the country's future growth is being diluted - the economy's future growth is being reduced
economic reform and liberalisation - improve the functioning of the economy
economic liberalisation - reduce regulation in the economy
the discount rate - interest rate charged by central bank when lending to other banks (See Economist glossary)
the bottom line - the most important point or factor in a situation
Other Vocabulary:
the outlook - what people think will happen in the future (See glossary)
promising - seems likely to succeed and be good
volatile - a situation that is likely to change suddenly and unexpectedly
volatile times ahead - in the near future, events will change suddenly and unexpectedly
in the forefront - a leader in this area
sought-after - in great demand because it is of very high quality or rare
X has a bearing on Y - X is relevant to Y, X is related to Y
have an important bearing on the global economy - is an important factor in the global economy
damage would soon be contained - damage could soon be controlled and limited
generous - a larger amount than is normal, necessary, or expected, given with kindness (See glossary)
novel ways - ways that are new and different from what has been tried before
the situation was grim - people felt negative and pessimistic about the situation
the perception - the way that you think about something, your impression
could prove premature - might be too early
claim many more casualties - many more people will be harmed and hurt financially
hopes revived - have new hope, positive and optimistic once again
increased pessimism - feel negative about the future
an unwelcome surprise - a bad thing that suddenly happened, that you didn't expect to happen
getting out of hand - becoming disorderly, chaotic, and uncontrollable
forewarn - warn before, warn ahead of time
general distrust - a situation in which most people do not trust each other
oversee - checking and monitoring something, to ensure that it works well
oversight - ensuring that something works well
detailed oversight - checking details, to ensure it works well
pitfalls - things that may go wrong and cause problems
instinct - what you feel from experience, immediately without much analysis and thought
reincarnation of Y - the form Y takes after it dies and comes back to life once again
lacklustre performance - not very good performance
dwindle - reduce or fall in number
activism - action to bring about social or political change (See Wikipedia)
judicial activism - when courts and judges act to bring about social change
politics on the streets - street protests (for example, PAD street protests)
populist - claiming to represent and defend the rights of the common people (note that the claim may not match reality, populist political platforms can also be used for personal gain)
populist leaders - political leaders who use the strategy of populism to win votes
on the horizon - will happen in the near future
little good news on the horizon - few good things likely to happen in future
ironically, X - X is the opposite of what you expect
a quagmire - a situation difficult to get out of (for example, the cart got stuck in a quagmire of mud)
political quagmire - a political situation that is difficult to get out of
intractable - a problem difficult to deal with and solve
opening up downside risks for the Thai economy - leading to the possibility of recession or econmomic slowdown in the Thai economy
