Like all countries in the world, the Bank of Thailand (and Monetary Policy Committee, or MPC) believes they can run monetary policy independently based on local economic conditions.
That belief is hard to fathom in today's liquid international capital market where money can move from one country to another in a matter of seconds. The real price to pay for not following international interest rate trends is not currency depreciation but a domestic liquidity drain as capital outflows take domestic liquidity with it. And that is a price that Thailand cannot afford.
Imagine when someone wants to take one US dollar out of Thailand to reinvest elsewhere for a higher yield, assuming the exchange rate is 35 baht per $1. That person will withdraw 35 baht from his/her bank account, exchange it, and electronically transfer that dollar to an account abroad for investment. That transaction would leave the Thai liquidity market with 35 baht less.
From the start of the year to the end of June 2022, $13.8 billion has left Thailand in this way. As a result, Thailand has lost 470.6 billion baht from domestic liquidity.
Capital outflow is not the only source of domestic liquidity drain. From January to May 2022, Thailand has incurred a $9 billion current account deficit, making total foreign exchange outflows $23.8 billion, or roughly about 800 billion baht.
The one trillion baht question is would a further US interest rate rise bring Thailand into a liquidity crisis? The answer is possibly.
At present, the Thai-US interest gap is 1.25%. But by the end of the year, this gap could widen to 2.25%. If the outflow is as severe as the first half of the year -- 800 billion baht -- the Thai liquidity market would risk running into crisis.
I have heard the pros and cons of the falling baht, which has depreciated by 11.27% compared to a year ago.
The biggest adverse effect of currency depreciation is inflation. A study in the Thammasat Economic Journal in 2013 concluded that a 1% in baht depreciation would cause a 0.02% rise in short-term inflation and 0.4% price rise over the long-term.
Without the baht depreciation, June's inflation rate could be as low as 3.16%, not 7.66% even with a $110 per barrel oil price. Currency depreciation is an issue not to be ignored when it comes to inflation.
The pros of baht depreciation are that depreciation help stimulate exports and boost tourism. I will say that the benefits of baht depreciation are diluted by domestic inflation, and, more importantly, depreciation of other currencies against US dollars.
The Japanese yen has depreciated faster than our currency while the Indian rupee has depreciated 6.8 % against US dollars. I believe that the net benefits of baht depreciation on exports and tourism are overstated.
Thai interest outlook is likely to be like this. First, the MPC and Bank of Thailand would raise interest rates by 25 basis points in their next three meetings, bringing the year-end policy rate (1-day repo rate) to 1.25%.
Second, the widening interest gap between Thailand and US, plus continued current account deficits, would induce more capital outflows.
Third, assuming that outflows are no less than 800 billion baht as happened in the first half of this year, a liquidity war could happen in the 3rd quarter, killing most SMEs with inadequate access to liquidity and pushing domestic rates close to double-digit levels. Under liquidity pressure, the Bank of Thailand will have two choices to make -- the right choice and the wrong choice.
The wrong choice is the Turkey (Turkiye) model. To keep domestic interest rates low and avoid a liquidity war, the Central Bank of the Republic of Turkey injected a large amount of liquidity into the system. The money supply increased by 70%, causing Turkish inflation to exceed 78%. Without such a mistake, Turkish inflation could be around 8%, which is about the same level as Thailand. That is why I called this strategy the wrong choice.
The right choice is the Tom Yum Kung model. After the crisis, foreign capital did not return to Thailand, creating a tight liquidity market. The Bank of Thailand, under guidance by the IMF, allowed markets to adjust naturally.
Real interest rates rose from 5.9% in 1998 to 11.9% in 1999 before plummeting to 6.4% and 5.3% in 2000 and 2001 respectively after the liquidity situation return to normal.
However, the much better choice is preventing capital flight from Thailand in the first place, by allowing Thai interest rates to move in tandem with the US's. High interest rates are also good for inflation control. Theoretically, Thailand should have a higher inflation than the US because we have the effect of baht depreciation on top of rising world commodity prices. Government intervention measures, which are falling one by one, keeps the inflation rate lower than reality.
The fate of the economy is in the hands of the Bank of Thailand. What choice they make, we will have to wait and see. My job is to describe the economic consequences of each choice.
I intend to write a "shorter-than-usual" main point today as I want to touch on the issue of Sri Lankan economic crisis. Obviously, Sri Lanka ran into today's economic crisis because of inadequate foreign reserves. Using the IMF standard, Sri Lanka should have at least $10 billion (covering six months of imports) and at least $5 billion (covering three months of imports) at a bare minimum in foreign exchange reserves.
Sri Lankan reserves started to fell below the $10 billion mark in the first quarter of 2018 and pass the critical threshold of $5 billion at the beginning of 2021. Should I say that this period coincides with the reign of President Gotabaya Rajapaksa. Rumour has it that current Sri Lankan foreign reserves are shockingly low at $25 million.
Furthermore, while foreign reserves were nose-diving, government debt ballooned from 83.7% of GDP in 2018 to 119% of GDP in 2021. This data indicates that Sri Lanka's economic problems stemmed from chronic mismanagement of the economy, not a Covid-induced crisis or even debt to China. The world has seen similar crises before in Latin America. (Totalitarian) governments never learn.
With international reserves covering 8.1 months of imports and public debt of 60% of GDP, Thailand does not have to fear a "debt crisis" like Sri Lanka. However, another $60 billion more of outflows will put Thailand's famous reserves in the yellow zone of less than six months of import coverage. The Bank of Thailand should take note. Every single dollar of our reserves is too precious to be lost.
