Bond Outlook

As for the local rates market, the debate over monetary policy is still on going between the Bank of Thailand and the Finance Ministry, albeit at a lower degree than previous months.

Playing devil's advocate, we raise the question as to why the ministry is so persistent in putting pressure on the BOT to cut rates. Maybe it's the case of the hot potato, throwing the burden to the BOT to stimulate the economy so that the ministry does not have to solely bear this burden via a higher budget deficit or, possibly, to help the ministry lower the financing of the budget deficit.

Recently, the Federation of Trade Industries struck a bad chord for the Finance Ministry, suggesting that tax rates be brought down.

Our analysis looks at Thailand's effective tax rate, that is, total tax revenue divided by nominal gross domestic product. Regardless of whether the Finance Ministry decides to cut taxes, we think the effective tax rate (presently at around 18 per cent) will fall as the economy slows down and consumption of higher taxrate goods (which generate excise taxes) will decline.

Put another way, if the ministry lowers the tax rate, it will likely generate a multiplier effect and help slow the decline of the tax base. If not, the tax revenue base will decline more rapidly as the economy slows - and, even with an unchanged tax rate, total tax revenue will nonetheless decline.

There is also an interesting relationship between inflation and tax revenues. Following our financial crisis, the overall tax revenue collected is a function of higher prices with a correlation of nearly 97 per cent. If revenue is largely a function of prices, then that is to say it most likely has very little to do with volume, since:

Value (or total tax revenue) = Price (general inflation) x Volume (or economic activity)

Wouldn't it be better to turn this around by making the total tax collected as a function of volume (or economic activity)?

Consider the sensitive issue almost every employer faces … income tax. As long as most can remember, Thailand has had a progressive income tax rate, which was never adjusted for inflation. As inflation increases, the next generation of employers is bumped higher and higher into the bigger percentage tax brackets. This would imply that after tax real disposable income decreases, and of course reduced spending power adds pressure to real consumption growth.

The verdict on the street is that the BOT will cut the repurchase rate next month, which we agree with. Traditionally, onemonth Tbills trade at about 19 basis points below the BOT repo rate, whether it is in the up or down cycle. Currently, it is trading at 47bps south of the BOT repo, which suggest a 25bps cut at next month's Monetary Policy Committee meeting. Going forward, we see the BOT repo falling to 3 per cent by the end of next year.