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Painful adjustment ahead as liquidity dwindles around the globe

Once upon a time, there was a car called "the Thai economy". In 2011, it was driving at a very slow speed since it ran into a huge puddle of water. In 2012, it broke away from the puddle and started to speed away at a near 6.5-per-cent growth rate, fuelled by the unsustainable octane of debt. In 2013, it ran out of octane and began to slow down.

It hit a plateau near October 2013 on Protest Street and the fuel left in the tank was about 2.25 per cent. What should the driver do to get the car accelerating again - step on the gas pedal and waste more of the 2.25 per cent left in the tank, or wait for the country's political tyre to be repaired before stepping on the gas? By the way…an EM storm is still looming.

The story is part of the economic epic of central banking that focuses on the dilemma of the effectiveness of monetary policy towards balancing the state of the economy. In the 1930s, the phrase "pushing on a string" was coined to underscore the fact that monetary policy is asymmetric, that is, monetary policy is more effective in dealing with inflationary pressure and less effec-tive in dealing with deflationary pressure.

Thailand's last Monetary Policy Committee (MPC) meeting highlights the rift in ideology of the effectiveness of moving the repurchase rate lower in an attempt to help compensate for the economic slowdown due to Thailand's political struggle. From an economic perspective, reducing the policy rate would seem to fall into the category of "pushing on a string".

Group dynamics might better help explain how the committee would decide. As the seemingly only functioning economic agency, the MPC may face social pressure to "do something", whatever that may be, to ease up on rates, despite knowing that the economy will be less responsive.

What further complicates easing monetary policy in Thailand is the external environment where the US Federal Reserve is unwinding its monetary policy accom-

modation, that is, the tapering of quantitative easing (QE). The International Monetary Fund has recently stressed the risk of larger capital outflows among emerging markets (EM).

One of the primary reasons why EM economies are facing the current challenges is the growing dependency on cheap money indirectly funded by the US Federal Reserve. Prior to the US Subprime Crisis, exports were the primary driver of most EM economic growth. Because of the global recession in 2009, with a contraction of 2.35 per cent, EM economies had to shift growth drivers to their own local markets with expansionary fiscal policies by running larger and larger budget deficits.

These deficits needed to be funded and without the global money supply newly generated by the Fed's series of QE, that would have not been possible. As the saying goes, "it takes two to tango". For example, foreign investors' position in Thai bonds was no more than Bt100 billion before QE1. Post-QE, that position swelled to Bt870

billion at its peak. That position has now fallen to Bt692 billion as of last week.

EM investors will err on the side of caution as this year will continue to prove to be another period of painful adjustment to QE tapering, as seen with Argentina and Turkey. The consensus is that 2014 is set to be the year that the Fed completely retires its QE programme. 2015, meanwhile, is expected to be the year that the Fed starts to normalise its ultra-low interest rate, the Fed funds rate.

Against this backdrop, the Fed's tango in support of EM debt would require foreign debt investors to be increasingly selective of risk and return. This in turn poses a greater challenge for EM countries that have grown accustomed to running larger budget deficits, which could learn a thing or two from the European debt crisis and the impending requirements for austerity.

The author Thiti Tantikulanan is Head of capital markets business division, Kasikornbank


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