Interest rates will rise but growth in 2011 will slow down

Dr Prasarn Trairatworakul, the Bank of Thailand's (BOT) governor, made it absolutely clear during his press conference last Wednesday that taming inflation is the top priority for Thailand this year.

The economy is expected to grow 4-5 per cent in 2011, a slower pace than the 8 per cent achieved last year, but inflation is rising because of higher prices of crude oil and other commodities in the global market. This will pose a new risk to the stability of the country's macro-economy.

Headline inflation is forecast to top 3.4 per cent this year, higher than 2010, but the fixed deposit rate for one year remains at a low of 1.25 per cent. As a result, the real interest rate is still significantly negative.

On January 12, the BOT's Monetary Policy Committee (MPC) raised its benchmark interest rate by another 25 basis points to 2.25 per cent. It was the fourth increase over the past year as the MPC pursued its rate normalisation policy. At this stage, it is widely expected that there will be further rate increases in the coming months by another 75-100 basis points.

During the January 12 MPC meeting, the vote for the fourth hike was a unanimous 7-0, signalling a strong likelihood that further increases will be forthcoming based on the current trend. By the end of this year, we could see the country's benchmark rate at 3 per cent or higher.

On the baht, Dr Prasarn also made it clear that he is ready to use all necessary measures to manage volatility in the currency market - starting from soft to medium, then harsh measures. These will depend on the circumstances, and capital controls should not be ruled out in the worst-case scenario.

Previously, massive foreign capital inflows into emerging markets in Asia, including Thailand, posed significant risks to exchange rate volatility and economic stability. The baht, for example, appreciated to a 13-year high against the dollar last October when it traded in the 29-per-dollar range, up more than 10 per cent since the start of 2010.

The rapid appreciation hurt the competitiveness of Thai exporters, prompting calls for stronger government action in managing the exchange rate policy.

This year, the effects of the US monetary policy, particularly its second round of quantitative easing (QE2) worth US$600 billion, should be less potent in emerging economies when compared to the much-bigger first round of quantitative easing in 2008-2009 following the collapse of US investment bank Lehman Brothers.

However, global economic uncertainties are not less than the previous year. In the US, recovery remains fragile due to the high unemployment rate of nearly 10 per cent and the collapse of housing prices. US authorities have said it will take at least 4-5 years for the job market to return to normal, with unemployment at around 5 per cent. Given this, it remains unclear how much more QE will be needed after the second round is finished in June, but it's clear that QE will be less and less effective.

In Europe, the public debt issue of Ireland, Greece, Portugal, Spain and Italy remains critical, and the integrity of the euro is now questionable, with the possibility that one member country or more could leave the euro over the next 12-24 months.

A brighter spot is Asia, with China continuing to grow at a high rate even though its monetary authorities have also started policy tightening on concern about rising inflation.

Overall, 2011 remains a big challenge for Dr Prasarn as far as monetary and currency policies are concerned.