WHAT'S GOING ON WITH THE THAI ECONOMY

UNCLAS SECTION 01 OF 05 BANGKOK 002916 SIPDIS SENSITIVE SIPDIS STATE FOR EAP/MLS AND EB TREASURY FOR OASIA COMMERCE FOR EAP/MAC/OKSA STATE PASS TO USTR FOR WEISEL STATE PASS TO FEDERAL RESERVE SAN FRANCISCO FOR DAN FINEMAN E.O. 12958: N/A TAGS: ECON EFIN ETRD PREL PGOV TH SUBJECT: WHAT'S GOING ON WITH THE THAI ECONOMY REF: A. 06 BANGKOK 6156 ¶B. 06 BANGKOK 7373 ¶C. BANGKOK 2037 ¶D. BANGKOK 2473 BANGKOK 00002916 001.2 OF 005 ¶1. (SBU) Summary: Thailand's GDP growth rate is decelerating rapidly and RTG officials are concerned about the short-term impact. However, this concern does not extend to changing policies that are having a clear impact on the primary reason for the economy's poor performance-loss of both consumer and business confidence. The political outlook remains confused and economic policies are discouraging foreign investment. The economy has enough inherent strength to prevent recession in the near term. However, the confidence of RTG leaders that Thailand can become more restrictive towards foreign business interests while neighboring countries become ever more competitive and the result will be improved post-election economic performance strikes many economists here as overly complacent if not altogether misguided. End Summary. ¶2. (U) The Thai economy continues to slow substantially. Net exports of goods and services contributed all but 0.2 percent of last year's 5 percent GDP increase. Bank of Thailand is now projecting 2007 GDP to be 3.8-4.8 percent, revised downwards in April from the previous 4-5 percent Bank projection. Many economists believe that the new projection remains substantially above what they expect and argue that the country will be lucky to achieve 3 percent growth this year. Certainly, many indicators are not positive: -Auto sales (a key measure of consumer confidence) down 16 percent year-to-date compared to the same period in 2006; -Property transactions down 20 percent; -Sales at fast-food chains flat for the first time since 2001; -Print ad sales down 20 percent although television ad spending is up slightly; -Pawnshop loans up 16 percent while corporate loans are flat; -Non-performing loans up slightly (from 4.12 percent of total loans at December 31 to 4.19 percent March 31-a reversal of the previous downward trend); -More late payments on credit cards; -Brokerage income down 76 percent and stock exchange trading volume down 43 percent over the same period last year; -Reports of reduced availability of overtime for factory workers; -No growth in overall imports and declines in imports of capital goods; -Private Consumption index down 0.5 percent Q1; -Private Investment Index down 1.7 percent Q1 (led by declines in sales of cement and commercial vehicles); -Consumer Confidence Index at its lowest point in five years; -Corporate income tax payments down 12.1 percent Q1; -Earnings of companies on SET50 index down 12 percent Q1; -Manufacturing Production index indicates a slowdown in production, especially sectors that depend more on domestic markets. Given the strong growth and positive leading indicators of Thailand's regional competitors, we assume much of the above is the result of Thailand's ongoing political uncertainty combined with some remarkably poor economic policy decisions. ¶3. (U) On the positive side of the ledger, the economy keeps growing because of the continued strength of (1) the tourism sector and (2) the export sector. Tourist arrivals increased 2.6 percent through April 2007 compared to the same period in ¶2006. Exports grew 18.5 percent Q1 in US$ terms (although only 4.7 percent in terms of unit value). Imports only grew by 0.1 percent in volume terms. This resulted in a Q1 US$5.4 billion current account surplus, continuing the accumulation of foreign currency reserves to more than US$70 billion ---a key factor contributing to the ongoing strength of the baht. Baht strength and low consumer demand have kept inflation low with CPI rising at a 1.8 percent rate this year. Gross external debt is down to 29.6 percent of GDP, with the government portion of this debt falling to 28.7 percent of GDP. Fitch Ratings accordingly maintained Thai sovereign debt at a BBB rating in its May annual report. BANGKOK 00002916 002.2 OF 005 BEHIND THE NUMBERS -------------- ¶4. (SBU) Most analysts we speak with believe the core problem with the Thai economy is lack of confidence. While this may sound simplistic and obvious, it reflects the contentious and confused nature of the current debate about Thai politics, society, and Thailand's place in the global economy that are currently roiling the country. Until these basic questions are resolved, Thais are hunkering down. Examples: - Over the past 12 months, the Thai stock market was the only one in the world reviewed by Bloomberg that experienced a negative return (down 2.6 percent.) The next worst performer was Tokyo which had an 8.2 percent gain. Thailand's regional competitors, Manila, Singapore, Kuala Lumpur and Jakarta enjoyed market appreciation of 45, 40, 43, and 41 percent respectively. The Thai market would have performed even more poorly were it not for foreign investors who have continued to be net buyers of Thai equities over the period. Thai investors, meanwhile, have continued their three-year trend of net selling Thai shares. This is despite Thai shares' much lower valuations and much higher dividend yield than other markets in the region. High bank liquidity also indicates that individuals are socking money away in bank deposits (which enjoy unlimited guarantee of principal by the RTG) and low bank lending for mortgages, automotive and corporate loans. - Thai businessmen in sectors as varied as chemicals, cement, footwear, banking, insurance and property development have all told us that while they are confident Thailand will be a good place to invest in the future, they are holding off making new investments here "until things are more clear." They have been telling us this for almost two years. Instead, they are running down their inventories (another contributor to the high current account surplus),squeezing as much as possible out of their existing production capacity, and investing in new operations in places like Vietnam and Cambodia. Because of the downturn in domestic consumption, output that was previously produced for the domestic market is being diverted to export markets despite slimmer margins - another contributor to the current account surplus and reduced corporate profitability. - Senior executives of the Government Savings Bank (GSB) and the Agricultural Bank (the two biggest lenders to rural Thais) confirmed press reports that rural businesses are suffering a severe downturn in business despite continued high prices for Thai agricultural goods. The bankers said that farmers are simply not spending money unless essential. They ascribed this frugality to their concerns about the loss of the Thaksin-era rural economic safety nets and the "sufficiency-economy" model the current government is espousing that promotes savings over consumption. An RTG promoted campaign to offer Bt5000, 18 month term loans to good existing customers of the GSB as a means to encourage consumption is instead reportedly being used by borrowers to pay back loans from loan sharks. WHAT THE RTG IS DOING ABOUT IT -------------- ¶5. (SBU) The RTG is well aware that the economy is not doing well and is looking for policies to quickly improve matters. Thus far, the search for economic stimulus has brought about a 1.5 percent reduction this year in the Bank of Thailand policy interest rate to 3.5 percent. In its May 23 statement accompanying a 50bp rate cut, The BoT signaled that further rate cuts were now less likely. One economist tells us that this sudden change in approach - despite continued weak economic numbers after the most rapid cut in rates since the 1997 financial crisis - was to compel consumers to start purchasing now rather than wait for the end of the BoT loosening cycle. However, as the local UBS economist wrote in a recent report, "While we believe that the BoT's decision to cut rates is the correct one, we do not believe that it will BANGKOK 00002916 003.2 OF 005 have a meaningful impact on domestic demand in the near term. What is more relevant to turning around the economy is turning around confidence." ¶6. (SBU) As evidenced in recent BoT-Ministry of Finance public fights on internet blogs, the BoT agrees that the impact of monetary policy will be limited and has encouraged MoF to use fiscal policy to stimulate domestic demand. The MoF acknowledges the need for stimulative fiscal policy, but argues that if the BoT had cut interest rates earlier and faster, then the MoF would not be required to apply fiscal stimulus so urgently. The stimulus package remains a vague work-in-progress but is expected to include two extensions to the Sky Train mass transit system (contracts to be awarded by August, delayed from April),increased spending by state-owned enterprises (especially petroleum giant PTT, although there is no clear time frame for the various projects) and small tax adjustments to make property purchases a better deal. The impact of the tax changes may be muted for some time as homebuyers are waiting for the BoT rate reduction cycle to play itself out before signing on for a new mortgage. THROW MONEY AT IT -------------- ¶7. (SBU) Other fiscal measures are meant to disburse the state budget more quickly. A special Bt44 billion (US$1.3 billion) in new funds for the state Specialized Financial Institutions (Agricultural Bank, Government Savings Bank, SME Bank, Government Housing Bank) are being promoted as a boon to economic activity in the rural areas. One obstacle to success for both these programs is that government bureaucrats are in "neutral gear" and apparently unwilling to approve expenditures. In Thailand's extremely hierarchical society, decisions are often pushed up the chain of command for clearance (and thus political cover for decisions). In the present environment in which civil servants expect that their current political masters will soon be gone, the already limited desire to put one's signature to an implementing decision is almost completely absent. This reluctance is especially pronounced in the areas that have attracted the attention of the corruption-busting Asset Examination Committee (AEC). A prime example of this is seen in the RTG Department of Revenue. Local accounting firms complain that since the Director General of the Department was sacked for providing a tax advice letter to the former PM's family (that the AEC subsequently determined was incorrect),tax rulings are simply no longer available from the Department. ¶8. (SBU) As for the Bt44 billion package, senior executives from two of the SFIs told us that 1) they have plenty of liquidity and so don't need the money and 2) the only way they could lend more would be to relax their credit standards, an issue for which they were severely criticized when the military staged the coup. They believe that the government announcement was simply for publicity purposes and little new lending was really expected by the policy-makers. The Finance Minister recently told the Ambassador that his ministry had "solved" the "neutral gear" problem regarding disbursements, but he did not say how and, according to one Thai participant in the meeting, "didn't really believe his own words." "FOREIGNERS LIKE TO COMPLAIN" -------------- ¶9. (SBU) Exacerbating all these problems have been a series of policy decisions that have contributed to significantly reduced new foreign direct investment and caused many to question the openness of Thailand to foreign investment in general. Changes in capital control regulations and proposed amendments to laws governing investment in the services sector have generated a deep concern among all major foreign investors in Thailand-concerns which have been dismissed by the RTG. One of our contacts related that Commerce Minister Krirk-Krai, responding to concerns expressed by his staff of BANGKOK 00002916 004.2 OF 005 foreign criticism of Thai policies, said "foreigners always like to complain. But we don't have to worry about it because we know we our actions are right." ¶10. (SBU) Senior officials at the Bank of Thailand and Ministry of Commerce acknowledge that the economy is running on one engine and missing out on new investment. But they note that government and corporate balance sheets are in good shape and there is plenty of liquidity in the economy. Economic policy makers are convinced that once elections are held and a new government is installed, pent-up consumer and business demand will be unleashed and the economy will quickly resume its historical growth rate. "We are simply building a good base from which to grow," an Assistant Governor of the BoT told us. ¶11. (SBU) The apparent confidence the current government places in foreign desire to invest in Thailand is combined with bureaucratic "neutral gear" at the Board of Investment (BOI),the agency responsible for promoting inward investment. We have been told by foreign and Thai companies that BOI has adopted a "take it or leave it" attitude to potential foreign investors asking about investment incentives. As one Thai industrial estates developer told us, "in Singapore they ask what they can do for the foreign investor; at BOI they just want to know what the foreign investor will do for Thailand. And then if the investor asks for some special help or some alteration of the published incentives, the BOI is completely inflexible." RISING RISK AND REDUCED RETURNS -------------- ¶12. (SBU) Portfolio managers tell us that the risk premium for Thailand has increased considerably and many fund managers with longer-term time horizons intend to remain uninvested in the Thai market until the political and policy risks are more easily quantified. Hedge funds and short-term traders, attracted by "the huge discounts available in Thailand" have demonstrated a willingness to continue making small bets here. ¶13. (SBU) A more quantitative indication of Thailand's increased risk rating is the increasing spread in 5 year Credit Default Swaps for Thai risk vs. narrowing spreads for Thailand's competitors. A Thai bank analyst report states that the risk premium for Thai securities is now second only to Indonesia among Thailand's regional competitors. Some economists argue that exacerbating the increased risk has been an expectation for reduced growth in Thailand going forward (due to RTG policy statements which state a preference for "happiness" and "sufficiency" over growth) and question why investors will come to Thailand if risks are rising while potential returns are falling. ¶14. (SBU) This perception of increased Thai risk also applies to fixed inward investment. U.S. companies with whom we have spoken say that in weighing their global options for new capacity, they now must include a greater weighting for Thai policy and political risk in their analysis than they had in previous years. This has been exacerbated by the ubiquitous demonstrations of affection for the King over the last two years and the concern (almost never voiced aloud but universally acknowledged) of how the country will respond when the frail 79 year-old monarch eventually passes from the scene. ¶15. (SBU) Comment: Starting with the communist revolution in China, Thailand enjoyed the serial elimination of many of its regional competitors for foreign investment and export markets. China, Vietnam, Laos, Cambodia, Burma and, to some extent India, all took themselves out of the game. Indonesia, the Philippines and at times Malaysia suffered political instability or bouts of xenophobia which similarly reduced their attractiveness to foreign investment. Thailand was one of the very few regional beacons of relative stability, predictability and economic openness. BANGKOK 00002916 005.2 OF 005 ¶16. (SBU) Comment continued: Thai policymakers seem not to recognize that the game has now changed. Thailand must compete with the new Asian tigers as well as the old ones. The country no longer offers particularly attractive labor or land costs and recent policies have caused many to question the transparency and predictability of future policies that could affect investment in Thailand. And then there is the opaque and confusing political scene to consider. Companies already invested in Thailand don't seem likely to leave (although lawyers in town tell us that they are getting a lot of work preparing exit plans for clients, just in case),but attracting new investment, even from Thais, is proving to be a problem. While momentum from past investments and fairly reliable infrastructure will keep the economy going for awhile, it is the "next investment dollar" that Thailand has lost out on over the past two years and will continue to forego should current policy trends continue. BOYCE