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Published on February 27, 2008

The Monetary Policy Committee is scheduled to meet today to determine the economic outlook and the appropriate interest-rate decision. The key question is whether the committee will cut the policy rate from the present 3.25 per cent to stimulate economic growth. Analysts believe that the banking authorities - who have been concerned over inflationary pressure all along - are likely to keep the interest rate unchanged at this time.  In fact, there is no urgent need to cut the interest rate, given a modest interest-rate differential between the Thai overnight rate of 3.25 per cent and the US Fed funds rate of 3 per cent.

The latest data show that in the final quarter of 2007, the Thai economy expanded 5.7 per cent, year on year. This should help provide considerable momentum for the economy going into the first quarter of 2008. Inflation is still a risk, with rising food prices and fuel costs which could affect low-income people in the longer term.

Prime Minister Samak Sundaravej will not want to reveal details of the salary increases for civil servants for fear of triggering inflationary pressure. The Commerce Ministry is trying to ask manufacturers and consumer-product companies to hold the current price levels of their goods. It will be a big task for the government to maintain price stability, and it will not allow events to lead to a sharp increase in wage demands.

Certainly, there has been political pressure for the central bank to cut its rate. The Finance Ministry has advised that the central bank should cut the rate by 50 basis points in order to stimulate the economy and also reduce pressure on the baht. Cutting the interest rate would also serve as an overture to remove capital controls, possibly over the next one or two months.

Tarisa Watanagase, the central bank governor, might not want to show that the bank is caving in to political pressure. At the moment, the banking authorities are trying to defend their policy of continuing to keep the capital controls, while the Finance Ministry is in favour of removing them to restore investor confidence.

"From an economic perspective, there is little reason for the Bank of Thailand to act next week. In fact, there are two overwhelming reasons for the central bank to keep its powder dry for the time being," said Frederic Neumann of HSBC's Asian Economics Team.

"First, inflation has accelerated much faster than initially expected, and still higher readings are likely on their way due to unfavourable base effects in the coming months. Cutting into a spike in the headline CPI would send the wrong message. Second, the Bank of Thailand may not wish to be seen as caving in to political demands quite so readily."

But this does not mean that there is no room for further interest-rate cuts. Going forward, domestic demand in Thailand remains weak. Besides, the differential between US and Thai interest rates does matter.

Jun Trinidad of CitiGroup believes that, going forward, the MPC is likely to take drastic action. "At the next MPC meeting on April 9, we expect a 50 basis point cut in response to an expected US Fed rate at 2.25 per cent; a strong baht outlook with the expected lifting of the exchange curbs; and the likelihood of disinflation risk during the quarter," Jun said.

If the gap in the Thai rate is too wide against the US rate, foreign capital will have further incentive to hold the baht, hence creating further pressure for it to rise. All in all, a stronger baht should help tame the inflation risk.

However, the financial markets are betting that the Thai authorities are eventually going to remove the capital controls. Recent upward baht pressure also reflects this anticipation. The political signal from the Finance Ministry is clear that the removal of the capital controls is imminent.

What Thai authorities may need to do is to introduce measures to cushion the baht in the event of the lifting of the capital controls. These measures may include taxing foreign portfolio investment in the fixed-income securities and support programmes for small- and medium-scale exporters, who are expected to be affected by the rising baht.

The Nation