European debt crisis comes into local focus
Over the past couple of months, the US economy has been the focus of investors following the US credit rating downgrade in July and persistently weak economic data.
However, in September and October, we will see European debt risks coming back into the spotlight.
Without new finance, Greece will likely default in 2012, as its return to capital market borrowing is virtually impossible. Two-year Greek bond yields are now trading at 55 per cent versus 3.4 per cent in Thailand. Basically, Greek bond yields are trading on a principal recovery basis, as opposed to interest on the principal. Meanwhile, the first Greek bailout programme (which started in May 2010) is also running into difficulty, with EU/IMF inspectors putting talks with Athens on hold while the authorities decide how to deal with a deficit overrun and missed targets on structural reforms.
Greece's deficit is now expected to overshoot the 7.6 per cent target for 2011 by quite a wide margin (we expect 8.5-9.0 per cent of GDP on current trends). With less than half of the deterioration in finances due to the worsening recession, the EU and IMF will need to see further efforts to boost revenues, cut spending, accelerate privatisations and speed up reforms, though Greece's finance minister Venizelos says that no additional measures to rein in the deficit are being considered right now.
Talks between Greece and the EU/IMF, currently on hold, will resume on September 14. Even assuming that the September tranche is paid out, the December quarterly payment may be at risk if the deficit is not improving materially and planned privatisation is slipping.
Continued IMF participation is contingent on there being adequate financing for Greece over the coming 12 months. If, in addition to the deficit overshoot, there are threats to the ratification of the new bailout package (from the July 21 EU summit), the IMF may be reluctant to contribute to further tranches.
What does this mean for Thailand? We expect the Bank of Thailand to keep rates on hold at its next monetary policy meeting on October 19 and to pause at 3.50 per cent (the current rate). While upside risks to inflation may emerge from wage hikes and fiscal stimulus, there are also downside pressures from the removal of fuel subsidies. The Bank of Thailand has also explicitly expressed its concern over the global economy and with policy rates of 3.5 per cent, it is arguably already in the vicinity of normal.
The Thai bond market has rallied over the past two months and the yield curve has flattened considerably, with the spread between the two-year and 10-year bonds around 0-10 basis points.
Given the concerns surrounding the US and European economies, we see Asian fixed income as the new safe haven destination for foreign investment flows. Indonesian, Korean, Malaysian and Thai bond markets should benefit as a result of these investment flows.
Danny Suwanapruti is a senior rates strategist for Standard Chartered Bank, based in Singapore.
