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Published on April 2, 2008

Under the inflation-targeting framework, the Bank of Thailand may prefer to keep the policy interest rate at the current level despite the rapid rise in oil prices.

This is to prevent the negative real interest rate from falling further and hence distorting savings behaviour. A lower-than-inflation deposit rate might stimulate huge consumption and further push up inflation. While the interest rates remain unchanged, the gap between domestic and US interest rates will widen, inducing capital inflows to the country.

However, it is questionable whether the current interest gap between Thailand and the US is significant enough to bring in foreign capital. Concurrently with the reduction of the US federal funds rate, other countries are pursuing different interest rate policies. For instance, China and Australia have raised their policy rates whereas the UK, the EU and South Korea have kept their interest rates unchanged. The policy interest rates of these countries are currently sitting at around 4.0 to 7.25 per cent, compared to the Bank of Thailand's rate of 3.5 per cent. In these circumstances Thailand might not be a priority choice for foreign investment. Nevertheless, capital inflows have inevitably resulted in a stronger baht. During the past three months, the value of the baht has appreciated by 7 per cent, compared with appreciation rates of 2 to 3 per cent for other currencies in the region. This has adversely affected the export sector which is the major sector driving the economy.

It seems that Thai policy-makers are now at a crossroads. They have to choose between keeping the inflation rate at a desired level and taking into consideration other factors in order to protect the baht's value so that it will not hurt exporters and the economy as a whole.

The Nation