Debt-ridden Thailand being sucked into whirlpool of deflation

Once an economy plunges into a deflationary spiral, it is extremely difficult to perk it up again. A dose of fiscal expansion and sharp rate cuts will have to be met with renewed confidence and fresh investment to create employment. The advanced economies – the United States, the UK, Japan and most recently Europe – have embarked on this policy of Keynesian spending and zero interest rates to pull themselves out of the severe slump, yet despite seven years of unorthodox methods a recovery is nowhere in sight.

Indeed, a recovery can never come under the current insurmountable level of indebtedness. Global debt has reached $200 trillion, or three times the size of the global GDP of $70 trillion.

The global economy can’t grow with more debt. Without debt restructuring, any recovery is out of the question.

Most Thai economists agree that deflation is not on the table yet, as the marginal fall in prices, caused by weak oil and food prices, will hit rock bottom soon after the economic pickup. 

“We expect headline inflation to bottom out and then pick up gradually from June onwards,” Phatra Securities reported on Tuesday. “However, we expect that headline inflation will not turn positive until the fourth quarter of 2015.”

Disinflation and deflation aside, Thailand is entering a dangerous period of economic slump and geopolitical risks. The downturn is caused by weak demand, both internally and externally. Household debt has reached Bt10.4 trillion, in a Thai economy whose total size is Bt13 trillion. Thai consumers no longer have much room to buy. To consume more they will have to further leverage their household balance sheet. They can’t create more debt.

This has resulted in an overcapacity or oversupply situation in the

economy. Businesses do not want to invest further because they can’t sell their goods or products. Banks are more reluctant to lend for fear of bad debts. Small and medium-scale enterprises are being hit hard by the lack of fresh credit and weak consumer demand.

Externally, the Thai export sector, which has been the engine of the Thai growth, is sputtering. The export sector has also registered shrinkage five months in a row, with figures for the first quarter of 2015 showing minus-4.3 per cent growth.

The explanation is either weak overseas demand or a lack of competitiveness in Thai industries. If overseas demand is the problem, there is nothing much we can do. If we cut the prices – by lowering the baht exchange rate – other countries can do the same, triggering a currency war. If the problem lies in exports’ loss of competitiveness, then Thai industries have to take responsibility.

So what should be the appropriate policy response from Thai authorities? Government spending grew almost 30 per cent in the first quarter of this year, offering a degree of economic stimulus. But we all know that fiscal stimulus has its limitations. One can’t expect the government to create a heavy debt burden year in and year out in order to perk up the economy. Japan and other welfare states have tried this medicine before and all ended up with unsustainable public debt. In the case of Japan, the government debt to GDP has reached a staggering 240 per cent. Creating more debt risks destroying the value of the yen, now hanging by a thread and on life support provided by the Bank of Japan’s government bond-buying programme.

Then it comes to the efficacy of monetary policy. The Bank of Thailand acted as if it had blood in its eyes when it cut its benchmark rate twice in a row to 1.50 per cent. The banking authorities must have seen disturbing signs in the economy, prompting them to cut the rates in a hurry. First, they want to send out a signal that they are providing an accommodative environment to stimulate domestic demand and growth. Second, they want to encourage the banks to extend further credit, particularly to the SMEs. Third, they want to rely on exchange rate targeting to boost exports.

In macroeconomic management, we can’t overdo both the fiscal expansion and the monetary stimulus. Government overspending will create debt burden for future generations. Besides, disbursements are not timely enough.

At the same time, monetary stimulus, if it is overcooked, discourages businesses, industry, households and the private sector in general from making appropriate adjustments to the actual prices.

For the Bank of Thailand’s low interest rate policy carries a double-barrel effect: lowering the cost of borrowing and weakening the baht.

But we can see that the banks have not cut their borrowing rates to match the central bank’s rate reduction. Thai banks’ profit margins remain at a historic high compared to banks in other countries, with profits of Bt50 billion in the first quarter of this year. A quick calculation projects bank profits at Bt200 billion this year. Banks are fattening their pocketbooks at the expense of the general economy and Thai borrowers. That’s why Bank of Thailand governor Prasarn Trairatvorakul was rather emotional when he found out that the banks had maintained their borrowing rates intact. That means Thai consumers are not benefiting from this round of rate cuts.

Now we come to the exchange rate targeting. The baht is losing value in a hurry under the Bank of Thailand’s deliberate policy to weaken the currency. Last month alone, the baht weakened by 4 per cent, almost touching Bt34 to the dollar. Siam Commercial Bank recently predicted exchange rate targeting could drive the baht down to Bt35 before the end of the year.

Destroying currency value is a bad money policy, but, strangely enough, most central bankers have adopted it in earnest.

Weakening a country’s currency might benefit the domestic export sector in the short term, but overall it harms the nation’s purchasing power.

Inflation will strike back with a vengeance. Under good money policy, the value of the currency remains stable over time. This benefits not only grass-roots citizens but also the overall economy, because all the participants do not have to play catch-up with runaway inflation.

A low interest rate environment, coupled with a weakening currency, discourages the economy from making the necessary adjustments. Bad companies, which should have folded, remain on the scene to create future burden. They use resources that they don’t deserve access to. A low interest rate policy also drives away savings. Capital accumulation gives way to speculative investment in the stock market or real estate. Retirees or pensioners earn nothing from their bank savings. They do not deserve this kind of punishment from bad money policy, in which they almost earn nothing from interest returns while at the same time the baht’s value diminishes steadily and harms their purchasing power.

In the end, the way out for Thailand is a combination of appropriate doses of fiscal and monetary medicine that allow the economy to adjust at its own pace. Thailand has already fallen into a debt trap, with combined private and government debt to GDP reaching 130 per cent. This high debt level will have to be brought down via restructuring, because raising incomes to pay down the debt looks almost impossible now given the global outlook. The government can tax the rich more to help out the poor. The banks must make less profit. The Bank of Thailand must not be tempted into a monetary trap, which would risk plunging the country into a zero interest rate environment. By that time it would be too late to save the baht.