A more stable Thai economy may withstand recession

Although the underlying political differences between the conservative elite and rural Thailand remain, the new Democrat-led government is likely to enjoy the support of key institutions.

This should provide a better platform for economic policy-making, enabling the Thai government to react in a timely manner to the looming global recession.

Although the economy is slowing rapidly, Thailand looks well positioned to avoid a recession, given a defensive domestic profile. Monetary policy is easing aggressively, and liquidity reserves provide a cushion.

A strong public balance sheet supports a pro-growth fiscal policy, while household savings and farm-income growth should provide leeway for consumption when confidence revives. Worst-case scenarios on politics now appear to be discounted, and we see potential incremental progress.

Although we believe Thailand's sovereign and corporate fundamentals are sound going into an anticipated global recession, it is vulnerable to contraction in external demand, given high economic dependence on exports and tourism (exports/GDP = 61 per cent).

While a sound fiscal position and sharply easing monetary policy should support initiatives to boost domestic demand, a domestic political crisis has led to lack of leadership, complicating the response to the economic downturn. However, a new Democrat-led coalition government holds out the promise of improved short-term stability and more concerted fiscal spending.

Lower external-demand growth should lead to a sharp drop in Thai exports, of which nearly 40 per cent are to the three major developed markets: the US, the EU and Japan.

JP Morgan Economics forecasts a 7-per-cent drop in exports next year. Further, tourism, which is 6.5per cent of GDP, should be hard hit by a fall in high season activity (which now accounts for 40 per cent of total tourism contribution) on the back of recent airport closures and recession in developed economies. This could subtract 1-2 percentage points from GDP growth spread between 2008 and 2009.

Employment, with 5 million in the export sector's workforce, appears vulnerable, with potential implications for consumption demand.

However, the sharp fall in the oil price has delivered a significant boost to real purchasing power of up to 14 per cent (oil prices have fallen more than 70 per cent from their peak in July, and transport and communications account for more than 20 per cent of monthly household expenditure). Financial stress should also be muted as Thai corporate balance sheets are lightly geared and external debt (US$67 billion [Bt2.3 trillion], 24per cent  of GDP) exposure is modest, with short-term external debt covered by international reserves.

The Thai banks' credit creation in the past cycle was conservative, with average growth of only 2 per cent from 2000-07, suggesting that deterioration in asset quality in the current down cycle should be contained. The Thai banks' average core tier-1 capital ratio of more than 11 per cent also provides a solid cushion against a rise in non-performing loans.

One area that may be easier for the coalition - and opposition - to agree on will be the need for fiscal stimulus. The government has already announced a package equal to almost 1 per cent of GDP that consists mainly of cash payments, which we now expect to be disbursed in next year's first quarter. Moreover, talk of tax cuts and other stimulus measures have been circulated in recent months, although no specific proposals have yet been made.

While we expect some extra stimulus measures via tax cuts and cash handouts to be announced in coming months, these are unlikely to be large enough completely to offset damage already done to the economy from the slowdown in external demand, period of extended political uncertainty and closure of Bangkok's airports.

One potential bright spot is that the Democrat candidate is the front-runner to win the election for Governor of Bangkok on January 11. With Parliament and Bangkok united under the Democrat party, the long-awaited infrastructure projects that have been on hold since Thaksin Shinawatra called snap elections in March 2006 could finally be started. This would provide a significant boost to growth; however, we would not expect such projects to actually get under way anytime before the second half of 2009, if not 2010, at the earliest.

Despite the potential for more stable politics, we view near-term economic risk to the downside, and we reiterate our concern that effective governance under the new coalition will still likely be challenging despite greater political stability. The Bank of Thailand (BOT) will continue cutting as inflation falls. CPI inflation slowed to 2.2 per cent on year in November from above 9 per cent in July.

Energy prices have fallen most rapidly, but inflationary pressures more broadly are also easing. We expect CPI inflation to fall further, likely printing negative in over-year-ago terms early next year. Core inflation is not expected to turn negative, but it should remain well below the upper band of the Bank of Thailand's 0-3.5 per cent inflation target.

We expect the BOT to remain aggressive in easing monetary policy and expect the policy rate to fall to 1 per cent  by mid-2009 from 2.7 per cent currently.

This has been compiled from JP Morgan Asia Pacific Economic Research, December 15, 2008.