Government must be firm on its financial commitment

They got off to a jolted start this week. As they are about to raise the deficit spending to Bt350 billion this fiscal year to combat the economic downturn, they would like the monetary authorities to tango with them through easier credit and further monetary loosening. Fiscal and monetary policies have to get along in tempo.

On Monday, they went to Bangkhunphrom Palace, the headquarters of the central bank, to discuss matters with Governor Tarisa Watanagase and her team of angels. In a way, they wanted to send out a friendly message that the government will reach out to work with all parties to salvage the sagging economy, which might barely grow at all this year.

But Tarisa proved to be a tough nut to crack. The central bank will not take part in soft lending to re-boot cash-strapped Thai companies because that would run against the law. Furthermore, any further monetary easing will be determined by an independent Monetary Policy Committee, which will issue its judgement based on economic conditions and prospects. In effect, the central bank will conduct its business as usual.

Abhisit emerged from the meeting to parrot the central bank's conservative line of financial conduct. Korn had already fumbled when, on the first day in office, he urged the central bank to relax the Basel II regulation covering capital adequacy rules and risk management of the banking system in order to help facilitate bank lending. The central bank's reply was that the commercial banks had been working on Basel II regulations and any holding back would send out a wrong signal to the financial markets. Even more so, liquidity was not a question because the problem had more to do with the banks' caution over the credit-worthiness, or ability to repay loans, of their customers.

It is understandable that Korn would like the central bank, through different tools and channels, to put more liquidity into the financial system to ease credit and lending. He has seen the economy slowing down sharply. He will definitely push a fiscal expansionary programme into the economy as quickly as possible but the banking system must also provide full cooperation.

Besides, Korn is also afraid that the gap between government revenue and expenditure will be too huge to bridge. The government will run a deficit of Bt350 billion this fiscal year and another Bt350 billion in fiscal 2010. As it has turned out, government revenue is falling sharply, pushing the deficit to Bt480 billion this 2009 fiscal year - not Bt350 billion. The shortfall, which is equivalent to 4.8 per cent of the gross domestic product, must be compensated by money from elsewhere.

If Korn requested very politely that the Finance Ministry issued bonds for the central bank to subscribe in order to finance the budget deficit, what would Tarisa say to this monetising of the debt, or printing of money for the system? Tarisa would reply, "Excuse me, can you say that again?"

The central bank is well behind the curve in its monetary policy, as evidenced by its shocking move to cut the interest rate by one full percentage point to 2.75 per cent last month. Many analysts expect Tarisa to cut the rate further by 50 basis points this month to prop up liquidity. The US policy rate has already fallen to the zero per cent range, following in the footsteps of the Japanese in confronting the liquidity trap.

The question is what will happen to the baht exchange rate if the gap between the US and the Thai rates are to be kept this high? Before the 1997 crisis, the high baht interest rates induced foreign capital inflow to speculate on the baht and the offshore banking operations under the Bangkok International Banking Facility (BIBF) to bring money onshore, resulting in the economic bubble.

If there is no other choice, Korn may have to ignore the central bank and resort to the government-owned banks, such as Krung Thai Bank, to do the dirty work instead. If Krung Thai Bank were to lead the way by cutting its lending rate to 3 per cent, it would shock the market, in a positive way though. Now the lending rate is about 6-7 per cent as the banks enjoy a fat interest rate differential of around four per cent. It would not hurt them much if their interest rate differential were to narrow. But it would give a big boost to Thai companies, which really need competitive funding to stay afloat.

Given the task ahead, you wouldn't want to be in the shoes of Abhisit and Korn at the moment. But a crisis situation justifies iron-fisted leadership.