THAILAND: TEN YEARS AFTER 1997 FINANCIAL CRISIS

UNCLAS SECTION 01 OF 03 BANGKOK 004639 SIPDIS SENSITIVE SIPDIS STATE FOR EAP/MLS AND EB STATE PASS TO USTR TREASURY FOR OASIA COMMERCE FOR EAP/MAC/OKSA FEDERAL RESERVE SAN FRANCISCO FOR DAN FINEMAN SINGAPORE FOR FINATT BAKER E.O. 12958: N/A TAGS: EFIN EINV ETRD ECON PGOV TH SUBJECT: THAILAND: TEN YEARS AFTER 1997 FINANCIAL CRISIS REF: (A) BANGKOK 4588 (B) BANGKOK 4465 BANGKOK 00004639 001.2 OF 003 ¶1. (SBU) SUMMARY: At the ten-year anniversary of the 1997 financial crisis, Thailand faces economic challenges of a much different nature. Gone are the days of easy loans fueling massive real estate speculation and luxury imports. Rather than fighting a currency devaluation, and exhausting its foreign exchange reserves in the process (as it did in 1997),Thailand today enjoys both current account and capital account surpluses, an appreciating exchange rate, and more than healthy foreign currency reserves. So where is the problem? A military coup in September 2006, subsequent political instability and a rash of nationalistic business decisions have harmed the investment climate. Thailand's economic growth trails that of its neighbors and is overly dependent on exports, which could now be harmed by a sub-prime induced slowdown in the U.S., Thailand's chief market. The Thai economy sorely needs a boost in domestic demand, productivity and infrastructure investment to keep pace with competition from Vietnam and China. Planned elections in December bring hopes of renewed political stability, but likely will result in a weak coalition government that will be hard pressed to provide the decisive economic leadership that Thailand needs. END SUMMARY. ¶2. (U) Ten years after the 1997 financial crisis, Thailand's economy has seen a steady, if unspectacular, recovery to sustainable growth levels. From a low point in 1998, when GDP contracted by 10.5 percent, Thailand has averaged 5.9 percent annual real growth since ¶2002. Inflation is now below 2 percent, and external debt is a manageable 32 percent of GDP (compared to over 75 percent in 1998). Thailand recorded a current account surplus of USD 6.2 billion for the first half of 2007. The capital account is also in surplus, with net inflows on track to exceed the USD 8.9 billion recorded in 2006, before the recent interruption of the sub-prime mortgage fallout. This balance of payments situation has caused the Thai baht to appreciate 18 percent in the past 12 months, well outpacing similar rises in other Asian currencies against the dollar (although more in line with those currencies if measured since 2004). Foreign reserves, once depleted during the 1997 crisis, now stand at over $73 billion and can cover 7-8 months' worth of imports. The government has run a balanced budget for the past two years. A LOST YEAR -------------- ¶3. (U) While such macroeconomic fundamentals would normally portend a period of healthy growth, Thai economists and investors, both foreign and domestic, are concerned about immediate prospects. Investor and consumer confidence indices are at ten-year lows. Domestic demand (consumption and investment) remains virtually flat after growing just 1 percent last year, and Thailand's growth rate is trailing that of its neighbors. Real GDP growth is expected to slow down to 4 percent, and possibly as low as 3.7 percent, this year. Vietnam and China, by comparison, are expected to meet or exceed their 8 to 10 percent annual growth from 2005 to 2007, according to World Bank figures. Those same figures show Indonesia, Philippines and Malaysia growing at an average of 5.5 percent annually over 2005-07. ¶4. (U) Moreover, Thailand's modest growth is due almost entirely to exports, which have risen sharply over the past 18 months. Exports, however, appear to be finally slowing with the appreciation of the baht making Thai goods more expensive abroad. Exports in July grew at an annualized rate of 5.9 percent, compared to 18.6 percent for the first six months of 2007 (although the Bank of Thailand on August 28 tried to attribute the fall to a temporary closure of refinery facilities for repair). Figures are likely to fall further in coming months as demand in the U.S. - Thailand's largest export market - continues to contract. ¶5. (U) Thailand's future growth in the short-to-medium term requires a combination of political stability, enhanced productivity, stimulated public investment (especially in infrastructure),and increased domestic demand to take the burden off of the export sector. So far, there are few indications of such on the horizon. On the contrary, in the ten months since last September's coup d'etat, the Thai government has: BANGKOK 00004639 002.2 OF 003 -- Imposed martial law on the entire country following the September coup, and subsequently lifting it in only 41 of the 76 provinces in late January. -- Put a hold on government investment expenditures, including long-delayed "megaprojects" such as expanded mass transit lines and provincial highway construction. -- Imposed a 30 percent reserve requirement on most capital inflows in December, only to remove those controls for portfolio investment the next day following a 15 percent drop in the stock market. -- Introduced amendments to the Foreign Business Act (FBA) that would restrict foreign ownership in selected sectors and possibly force foreign investors to retroactively give up majority voting rights or divest within a given period. (This bill has been retracted and it's future status is uncertain - see ref A.) -- Forwarded to the National Legislative Assembly (NLA) additional bills, including a draft Insurance Act and Retail Act, provisions of which include measures to limit the expansion of foreign investment in these industries. SWIMMING IN DOLLARS - CRISIS OR OPPORTUNITY? -------------- ¶6. (U) Rather than focus on government missteps, a number of media pundits, exporters and economists have termed the baht's appreciation a new "crisis" and are urging the BOT to maintain or weaken the exchange rate by: 1) aggressively buying U.S. dollars in currency markets and 2) sharply cutting interest rates by 1.0 to 1.5 percent. Supporters of this view claim that over 2 million export-related jobs will be threatened if the baht breaks the Bt 32/USD barrier. Most of those jobs will be lost in labor-intensive industries such as textiles, or producers of agricultural and seafood products - the latter being more price sensitive than electronics or machinery products that are vertically integrated in foreign production chains. ¶7. (U) These critics dismiss the onerous task faced by the Bank of Thailand (BOT) of soaking up dollars produced by the dual current/capital surpluses. "Defending the currency by buying the dollar should be easier than by selling the dollar as in 1997," said one. "If the central bank had cut interest rates more aggressively and earlier," he added, "it would have succeeded in maintaining baht stability." According to this line, lower interest rates will keep the BOT's sterilization costs low when issuing bonds to control baht liquidity. The BOT also has positive carry on its baht debt (earning more on its U.S. Treasury bonds than it pays out on baht debt). As for concerns about an excessive foreign exchange buildup, another economist said, "If anyone worried about foreign exchange losses (through a weakened dollar),China's central bank officials would have been executed by now." ¶8. (U) Other economists, who, fortunately, include those in charge at the BOT, maintain that Thailand cannot purchase dollars indefinitely. Besides the potentially huge foreign exchange valuation losses accruing from a weaker dollar, Thailand's balance sheet already includes 1 trillion baht worth of baht-denominated debt through sterilization measures, compared to 800 billion baht of base money. Further, Thailand does not have a government investment corporation with which to invest the reserves (a situation that many economists would prefer to keep, due to the temptation to take on higher risk). ¶9. (U) In a July speech, BOT Deputy Governor Bandid Nijathaworn noted these risks in addition to the difficulty of targeting the exchange rate and inflation simultaneously. "There is a risk that the central bank may cut interest rates too much," he said, "sowing the seeds for inflation and an asset price boom down the road as well." Most observers believe Finance Minister Chalongphob is in full agreement with the BOT economists, who prefer only occasional currency interventions to reduce volatility while encouraging more capital outflows to relieve the surplus. ¶10. (U) Economist Supavud Saicheua, however, goes further, saying that the exchange rate should be left alone: "The appreciation of the baht must be seen for what it is: an increase in Thailand's BANGKOK 00004639 003.2 OF 003 purchasing power, which presents us with the opportunity to buy the many things we need from the world market." The current account surplus, he added, "may have been essential during 1997-2004, when Thailand had to generate excess dollars to repay foreign debt, repay the IMF and build up international reserves lost during the 1997 crisis." Supavud bemoans Thailand's reliance on exports, noting that the pre-1997 baht was even stronger, at Bt 25/USD, and exports only 35 percent of GDP (compared to Bt 34/USD and 60 percent today). ¶11. (U) Ideally, the higher purchasing power of the baht should allow Thailand to re-tool its production facilities, physical infrastructure, and research and development base to prepare to compete in coming years. It is also an opportunity for Thai consumers to use their buying power on imported goods. However, voices such as Supavud's are being eclipsed by the clamor for exchange rate protection emanating from large exporters, such as shrimp and tuna processing firms with low margins. Thirapong Chansiri, president of the world's largest tuna cannery, Thai Union Frozen Foods, said on August 26, "Would it really help the country if we moved to Vietnam?" Better to maintain a favorable exchange rate, he said. He added that "while we in the past complained about politicians with conflicts of interest, this new government, run by bureaucrats, isn't accomplishing anything, and I'm really desperate about the future." ¶12. (SBU) While a seemingly paralyzed government and low consumer and investor confidence continue to hold sway, optimists hope that national elections, now scheduled for December 23 will remove enough political uncertainty to unleash a broad growth rebound in 2008. But those elections are likely to result in a weak coalition government, as the August 19 constitutional referendum vote revealed that sharp schisms remain between the Bangkok elite and the provincial voter base of ex-PM Thaksin's disbanded Thai Rak Thai (TRT) party (ref C). ¶13. (SBU) Comment: A weak democratic government will certainly be an improvement over the current coup-installed one, but will be hard pressed to provide decisive economic leadership in the months ahead. An interesting aspect of the current political maneuvering is the reappearance of ex-PM Gen. Chavalit Yongchaiyudh, angling to lead an alliance of several new TRT-based parties. He ended his last term as Prime Minister almost ten years ago, four months after he touched off the 1997 crisis with his fateful but unavoidable decision to float the baht. BOYCE