Guru Speak

We have seen yet another cut in the policy rate from the Monetary Policy Committee at the Bank of Thailand.

The 50basispoint chop was more or less within market expec¬tations.

In response to the MPC's move, commercial banks also cut their interest rates for both deposits and loans.

But how low can interest rates go and how effective are they as a tool for economic stimulation?

First of all, lower interest rates are supposed to encourage the private sector, both corporations and individuals, to make capital investments or borrow for spend¬ing (or spend their savings..!).

However, when it comes to bad times we often see an aboutface change in the consumer mindset in Thailand. We normally miscon¬strue Thais as having a knack for enjoying life and spending freely.

But that only happens with a favourable environment and buoy¬ant economy, whereas, in bad times, like post1997, we saw a sharp cut in consumption and investment all over (for a different reason - overcapacity … per¬haps).

Interest rates had been declining after a sharp spike post1997, which reversed to below 2 per cent by 2002. Rates bottomed out at 1.0 per cent on all three, six and 12month deposits and stayed there over the period of 2003-2005.

At the same time, loan rates went as low as 5.75 per cent. All the while, we saw steady growth of bank deposits against a decline in bank lending. More sig¬nificantly, we witnessed a strong resurgence of mutual funds, espe¬cially lowrisk money market and bond funds.

From 2002-2004, bank deposits grew more than B500 billion while bank loans shrank by B100 billion. Mutual funds grew more than B200 billion in the same period.

This time around, we foresee healthy growth in deposit and other savings alternatives, maybe more in mutual funds and other instruments. But a quick recovery following such a low interest rate environment should still be far off.

We are of the view that in this gloomy environment, only aggres¬sive government spending and confidenceboosting campaigns would help shore up economic activities, and in time reignite growth momentum for the Thai economy again.

We also foresee that the low interest rate environment will be with us for a considerable time, unlike 2003-2005 when interest rates remained low for as long as three years.

However, with expectations of massive longerterm funding needed by the government, we will be seeing a rather steep yield curve, meaning that longer term paper of five to 10 years will give returns significantly more than those of shortdated tenures.

Furthermore, corporate credit spreads - interest rates that cor¬porate bond issuers pay above government paper of similar tenor and features - is at a near alltime high.

In this environment, one would question the merit of investing in corporate bonds. With very top names like large energy or build¬ing material firms paying more than 2 percentage points above comparable government paper, we think that any risk is commensu¬rate with the returns.

Therefore, we would like to rec¬ommend an additional mix of longerterm government and highgrade corporate paper for invest¬ment portfolios at the moment. A targeted yield of 35 per cent should be reasonable.

Adisorn Sermchaiwong is executive vice president, Saving and Investment Products Division