External factors will determine monetary policy
The Thai central bank has to consider various issues beyond its control before deciding on policies that will affect the currency and interest ratesThe Bank of Thailand is facing a challenge on the management of monetary policy, with the Thai baht strengthening largely because of external factors over which the central bank has no control. The baht has gained 2.2 per cent against the US dollar, largely because of the US administration's "quantitative easing" policy, or money printing, which has resulted in a weakening of the dollar against other currencies.
At the same time, the new Japanese government under Prime Minister Shinzo Abe has also implemented quantitative easing and targeted a 2-per-cent inflation rate in a bid to end the country's decade-long economic slump. In fact, the Japanese yen has depreciated by over 10 per cent since November due to economic stimulus campaigns.
With major economies weakening their currencies, the baht has been under pressure from capital inflow. The Bank of Thailand will thus find it difficult to control the level of the baht amid this flexible situation.
Germany recently criticised the Japanese government for weakening its currency. South Korea has urged the Group of 20 industrial and developing nations to discuss the impact of monetary easing in the US, Japan and Europe in its meeting next month.
The baht is a small player in this game of competitive devaluation of currencies. Governments often want a say in monetary policy, because by doing so they can promote their particular policies. But, traditionally, political intervention is kept to a minimum to ensure the stability of monetary policy over the long term.
With increasing lobbying from exporters, along with the government's addiction to politically tempting quick fixes, the Bank of Thailand is facing a major challenge. Exporters, who obviously stand to lose from an appreciating baht, are calling for an interest-rate cut to weaken it. Bank of Thailand chairman Virabongsa Ramangkura also prefers to slash the policy rate in order to boost domestic consumption. The policy rate has stood at 2.75 per cent since October 17.
But there are other factors to take into consideration. For example, has the baht moved within an acceptable range compared with other currencies in the region?
The Bank of Thailand has so far succeeded in implementing macro prudential measures to prevent any unexpected impact. In fact, the level of the baht is not the sole factor that will affect the competitiveness of Thai exports. A more important factor is the purchasing power of trading partners and the quality of our exports. Therefore, a cut in the policy rate might not be a guaranteed way to deter inflow, as anticipated. On the other hand, a quick-fix policy could have negative repercussions. For instance, it could reduce the incentive to save and thus result in unmanageable inflation.
Decision-makers will have to weigh the short-term and long-term effects before making a decision to reduce the level of the baht, as well as anticipate how events will evolve in the future.
The global economy is changing. The aggressive monetary easing in Japan might result in economic vitality. The upcoming release of US economic data could be good news, showing that the American economy is in the process of recovery. If this turns out to be the case, it would ease the pressure on the baht.
In addition, a strong baht could help stabilise prices such as that of imported gasoline. Importers of goods and machinery will also benefit from stabilised import costs, especially as the government will soon have to import machinery to finance its massive infrastructure projects, to the tune of Bt2 trillion.
Meanwhile there are other measures that decision-makers should take into consideration to stem short-term inflows, such as capital controls akin to the measures taken in 2006. Brazil uses a financial-transaction tax and adjusts the rate according to the prevailing situation in order to stem capital inflow. The transaction tax rate in Brazil was boosted from its original 2 per cent to 6 per cent to correspond with the current situation.
The Thai central bank will have to consider all these options and closely monitor the situation to ensure an effective response.