True message behind policy rate cut more important than cut itself

The key questions that follow these moves are, first, are they the right way to support the economy under current conditions; second, what effects in the market might we see from the relaxation of the FX rules; and third, will there be any further monetary easing that we should be aware of in the near future?

Our short answer to the first question is yes.

It is not so much because low interest rates mean a significant boost in new loans, or that these relaxations will have a critical impact on money flows, which could suddenly weaken the baht and help our exports. The cost of funds has never been a major problem for our economy, and a 25-basis-point cut now might only be able to contribute a 10-basis-point increase to 2015 GDP growth (according to by TMB Analytics), which is very small.

On the capital-flow relaxation, there have been plenty of liberalisation policies announced by the BOT. However, they are part of the so-called second phase of the central bank’s long-term master plan. Their objectives are to ease the capital controls, which may help create more balanced fund inflows and outflows, but will not necessarily make the baht weaker.

Moreover, the success of the policies will probably require other deeper fundamental changes to the market and its participants. For example, a policy to stimulate residents’ investments in securities abroad through onshore banks will also require better access to foreign-market information and more education for investors. Thus, in our view, none of them will be a key market mover.

So why exactly do we think that these were the right moves from the BOT?

In our view, these moves are signals that the central bank has sent to the market. They imply that the BOT will pay closer attention to the exchange rate. We believe that this message, not the economic impact from rate cuts or FX relaxation, was the key factor that pushed the US dollar/baht exchange rate up more than 1 per cent from around 32.70 to around 33.20 the following week.

Despite the uncertain global economic conditions, we believe that the market can expect to see the BOT intervene more actively if the baht’s strength starts to make it more difficult for our exporters to compete with other economies.

In reality, the key to successful signalling from the central bank is not only the policy itself, but also the timing and the market conditions at the time of announcement.

When it comes down to the choice of either gradual or rapid changes, we believe a gradual change is better for the Thai economy. Although there is plenty of cost – limited inflow/outflow effect, adjustment cost, loss of credibility from international creditors, for example – gradual policy changes allow for smoother adjustment, lower market volatility, and much-needed time for market participants to absorb the information and prepare for the adjustment.

We believe that the BOT shares the same view to prevent against sudden turmoil in the market in such fragile economic conditions. Therefore, what we can expect in the near future is that further relaxation and deregulation of Thailand’s capital account should come slowly if the baht starts to create a downside risk to the Kingdom’s export prospects.

Although theory may suggest that free market forces are what work best, we believe that the BOT’s support and intervention are needed, and will continue to come. Without them, the economy will be more likely to be exposed to external shocks from other troubled economies.

In these times when we are not invincible to global surprises, accurate and sound macroeconomic policy to support the pillars of the economy are keys to survival.

Dr Jitipol Puksamatanan is an economist at TMB Analytics, the economic analysis unit at TMB Bank. He can be reached at [email protected]. Views expressed in this article are those of the author and not necessarily of TMB Bank or its executives.