Govt must push banks to cut loan rate

If Prime Minister Abhisit Vejjajiva and Finance Minister Korn Chatikavanij are to create a lasting impact with their economic management, they will need to bring down interest rates for borrowers and implement an economic stimulus package that creates real investment, rather than merely boost consumption.

Bringing down interest rates will require some tough decisions, and it might be necessary for both men to step on some toes.

The Thai interest rate structure does not resemble anything one is likely to find in an economics textbook.

At present, the Bank of Thailand's policy rate stands at 2.75 per cent. The commercial banks quote one-year deposits at 1.75 per cent, while charging borrowers 6.75 to 7 per cent. This interest rate structure is abnormal.

Unlike the US federal funds rate, the BOT's policy rate has no direct impact on the banking market at all. If the BOT were to cut its policy rate by another 50 basis points to 2.25

per cent this month, it would do little to bring down commercial bank rates.

Thai banks have traditionally enjoyed a fat interest margin. Their net interest margin - the differential between deposit and borrowing rates - is between 3.2 and 4 per cent. In reality, banks should be able to survive on an interest margin of 1.50 per cent.

However, the overriding concern among central bankers is that the financial system remains stable, as banks are the nerve centre of the economy. As was shown in the United States and Europe recently, the major banks are too big to be allowed to fail, with trillions of US dollars being spent on government bailouts.

During these economic hard times, consumers, as well as corporate and SME borrowers, all need to reduce their interest burdens.

"If the government can bring

the borrowing rate down to 3 per cent, it would really help the exporters and the SMEs, which are now struggling to stay alive," said a money manager.

"Finance Minister Korn may exert his influence on Krung Thai Bank so that it moves to cut the borrowing rate to 3 per cent. Let's see what other banks do after that."

Another method of bringing down interest rates is to flood the financial system with massive liquidity.

A former central bank official said that because cutting the repurchase rate has little impact in bringing down interest rates, the BOT should inject massive liquidity into the financial system.

"It can do so by redeeming the BOT bonds issued as part of its money market operations. Buying back the BOT bonds would amount to injecting baht liquidity into the system. Flooding the system with massive liquidity will eventually force the commercial banks to cut rates or to lend money, because they will have too much money on hand," he said.

There is now some Bt1.5 trillion in outstanding BOT bonds in the domestic market. If, as a first step, some Bt200 billion to Bt300 billion of this were to be redeemed by the central bank, it would inject baht liquidity into the financial system of an equal amount.

Commercial banks would have no option but to cut interest rates.

Flooding the financial system with massive liquidity at this time would not create inflationary pressure because the velocity of money is low. In 1998, at the height of the financial crisis, excess liquidity of Bt700 billion to Bt800 billion in the financial system did not bring about inflationary pressure at all.

Abhisit's economic stimulus package appears to be directed toward increasing consumption or income distribution, rather than creating government investment to offset the fall in private investment. Government handouts aimed at increasing consumption among the poor as part of the welfare safety net will stimulate the economy, but is not sustainable in the way that investment is.

Dr Vichit Suraphongchai, the executive chairman of Siam Commercial Bank, also questions the efficacy of the stimulus package, saying there will be pressure from too many interest groups demanding government assistance.

"The most important problem is how the government is going to deal with unemployment. People will lose their jobs. How are they going to be helped?" he said.

Earlier, Achana Waikhuamdee, the chief economist at the central bank, was right to suggest that the government should come up with unconventional programmes or smaller investment projects that can be implemented quickly to help boost the economy. Mega-projects take time to implement.

Korn spent most of his career in investment banking and creating private investment projects. Now, he will need to focus on creating government investment projects, in addition to pushing government agencies and state enterprises to accelerate their investment programmes.

During the Thaksin era, which was marked by populist policies, it was the export sector, driven by the baht devaluation and supported by a strong global economy, that helped put the Thai economy back on a growth track and a more stable path. Thaksin's populist policies were insignificant in driving the Thai economy when compared with the export sector.

The challenge facing the Abhisit government is greater because the global economy is entering a recession.

To enable the Thai economy to recover, the Abhisit government will have to revive domestic consumption and investment through government spending, which has always proved cumbersome and less effective than private sector-led recovery.