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Cablegate: Thai Economy Continues to Slow

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 BANGKOK 005217

SIPDIS

SENSITIVE

STATE FOR EAP/BCLTV AND EB
STATE PASS TO USTR FOR WEISEL AND COEN
TREASURY FOR OASIA
COMMERCE FOR 4430/EAP/MAC/KSA

E.O. 12958: N/A
TAGS: ECON EFIN ETRD TH
SUBJECT: THAI ECONOMY CONTINUES TO SLOW

REF: A. BANGKOK 3463
B. BANGKOK 2137
C. BANGKOK1266
D. BANGKOK 1237

1. Sensitive but Unclassified. not for Internet Distribution.

2. (SBU) Summary: Increasing oil prices exacerbated a turn
in Thailand's business cycle resulting in GDP growth of 3.3
percent in 2Q 2005. Continued declines in consumer and
business sentiment caused weakness in consumer spending and
private investment leaving 12 percent growth in imports as
the primary source of economic strength. The 35 percent
increase in imports, primarily oil, more than offset the
export growth and resulted in a large Current Account deficit
over the fist half of the year. The Bank of Thailand is
expected to increase its policy interest rate by as much as 1
percent by year-end in a bid to control inflation, maintain
stability in the baht and reduce the negative spread between
nominal and real interest rates. This is somewhat at
cross-purposes with RTG policy which would prefer a
relatively weaker baht and continued low interest rates to
augment the fiscal stimulus policies it has put in place.
Economists have reduced 2005 GDP growth forecasts to 3.5-4.5
percent from 4.5-5.5 percent thre
e months earlier. We believe that the government's strong
fiscal position, commercial bank's improved financial
condition and strong corporate balance sheets will see
Thailand through what the Bank of Thailand terms "the year of
adjustment which tests the economy's resilience." The main
risk factors to this upbeat scenario are continued increases
in world oil prices and weakening in the economies of
Thailand's major trading partners. End Summary.

Economy Growing More Slowly
----------------------------------------

3. (U) The Thai economy grew 3.3 percent in the first quarter
compared to the same period last year, and declined 0.6
percent from the last quarter of 2004. Initial projections
for the 2nd 2005 quarter show no improvement. This continues
a trend of declining GDP growth over the past 1.25 years. The
Bank of Thailand attributes the relatively poor economic
performance so far this year primarily to the increase in
world energy prices. This global problem has been exacerbated
in Thailand by the effects of the December 26 tsunami,
drought in certain agricultural regions and the on-going
violence in three far southern provinces of the country. In
addition, the global economy grew only modestly over the past
year limiting growth opportunities for Thai exports.

The Fallout from High Oil Prices
----------------------------------------

4. (U) There is no doubt that the rise in oil prices has
been a major contributor to Thailand's swing to deficit in
its current account, from a US$7.1 billion surplus in 2004 to
a US$6.2 billion deficit in 2005's first half. Foreign
exchange reserves have declined modestly over the first half
from US$49.8 billion to US$48.4 billion-about 3.5 months of
imports; 3.6 times short-term external debt. Analysts
estimate that oil costs have doubled, going from 4 to 8
percent of GDP and subtracting about 5.5 percent from the
country's rate of growth. Oil has accounted for more than 33
percent of total Thai imports this year. In addition, the
cost to Thai consumers and businesses was more keenly felt
than were last year's increases in world energy prices due to
the end of the RTG's subsidy on diesel beginning on July 13.
Diesel prices at the pump have increased 4.1 percent and
would have been up by around 10 percent had excise taxes on
the fuel not been reduced at the same time as the subsidy
ended. According to the B
ank of Thailand, the increase in fuel prices has been the key
cause of inflation rising to 5.3 percent in July (core 1.9
percent). 2004 headline inflation was 2.7 percent.

5. (SBU) The deficit in the current account, rising prices
and the negative news from natural causes have all taken a
toll on consumer and business sentiment. Both these
indicators have been declining for the past six quarters and
business sentiment is at its lowest point since 2001. This is
reflected in both the Private Consumption Index (growing at
only 0.3 percent in 1H 2005) and low rates of fixed asset
formation, even though capacity utilization continues to run
above 70 percent. Consumer purchasing power going forward
will be further constrained by recent Bank of Thailand moves
to restrict credit growth in the sub-prime market (from
concern that these consumers were becoming over-extended) and
interest rates that are expected to increase 75-100 basis
points by year-end as the Central Bank tries to rein in
inflation and increase savings by reducing the 3.5 percent
negative spread between real and nominal short-term interest
rates. The Monetary Policy Committee (equivalent in function
to the U.S. Federal
Open Markets Committee) is faced with pressure to raise
interest rates to protect the value of the Baht and reduce
inflation even as the RTG is anxious to keep rates at a level
that continues to be a stimulus to the economy.

Fiscal Stimulus, But Not Much This Year
--------------------------------------------- ------

6. (SBU) As reported in reftels, the RTG must identify the
next driver for economic growth now that consumers are
nearing their maximum debt levels and private investment is
not picking up the slack. While most analysts are sanguine
that recent positive growth in the economies of Thailand's
major trading partners should translate into a renewed
upsurge in Thai exports, we question the ability of Thailand
to meet any significant increased demand given the lack of
investment in increased capacity. The government's five-year
"megaprojects" infrastructure development program remains on
the drawing board at this point, slowed by the huge size of
the proposed projects, the need to create institutional
capacity to manage several large projects simultaneously, the
RTG's desire to postpone projects requiring large amounts of
imported inputs while the current account is in deficit and
reported in-fighting over which companies will be awarded
these contracts. Analysts don't expect any real progress on
these projects un
til sometime in 2006.

7. (SBU) To stimulate the economy this year, the government
is taking the following actions:
-Bt50 billion accelerated disbursement of RTG budget.
-5 percent increase in salaries of civil servants
-5 percent increase in pension payments
- 3.5 percent increase of the minimum wage
- Directing state-owned commercial banks to accelerate a loan
expansion program (Note: Most commercial banks have tightened
lending standards for loans to SMEs in anticipation that
slower economic growth could result in tougher trading
conditions for small companies and, therefore, more potential
loan defaults. End note.)
-Increase in the "Village Fund" program to direct more funds
to rural areas.
Due to a balanced budget, a government debt/GDP ratio of
around 45 percent, and continued strong growth in government
revenue (up 10 percent in 1H 2005), the RTG has the fiscal
wherewithal to undertake these programs without undue risk.

8. (SBU) Newly appointed Finance Minister Thanong Bidaya has
pledged to make financial stability his key concern. However,
he has also said that he is investigating means to reduce
consumer debt burdens. While it is unclear how he will
accomplish this, some analysts are concerned that it will
result in some sort of socialization of consumer debts as a
means to provide consumers with the ability to re-leverage
themselves and again act as a stimulant to the domestic
economy through their renewed purchasing power. Meanwhile,
private commercial banks have tightened up their standards
and practices for consumer loans and credit cards. The RTG
is also studying ways to restructure the debt of small
farmers suffering from drought. We expect that this will be
extended to small farmers in general via the RTG-owned
special purpose banks (Bank for Agriculture and Agricultural
Cooperatives and the Government Savings Bank.) Note: The
rural areas are the political base of PM Thaksin and his
party. End Note.

Oil Anomaly
----------------

9. (SBU) To reverse the current account deficit, the RTG has
asked Thai Airways to delay purchase of two A340 jets and
requested importers not to stockpile goods, especially oil,
gold and steel which have been major contributors to the
deficit. We noted that customs statistics show the value of
energy imports in 1H 2005 increased over 80 percent in dollar
terms and over 100 percent in May and June from the previous
year. The increase in oil prices only account for about 60
percent of this increase in imports. Meanwhile, the Ministry
of Energy reports that overall domestic demand for refined
product declined 16 percent over the 1H 2005 in response to a
slowing economy and increased prices and that there was no
net increase in oil imports. The official Bank of Thailand
explanation for this anomaly is that Thai customs is
reporting imports in arrears with a mismatch between when oil
is contracted, imported and accounted for while the Ministry
of Energy records imports based on invoice dates. Industry
contacts also suggest that 2004 customs statistics understate
imports, thereby distorting year-over-year comparisons.

10. (SBU) A different explanation put forward by some
analysts is that oil companies may have been importing large
amounts of oil (stockpiling) earlier in the year to gain
inventory profits, i.e. they import crude at prices
prevailing earlier this year but sell refined product later
in the year and price the refined product at the then
(higher) prevailing world prices. There is little available
excess crude storage capacity in Thailand so, if this sort of
speculation did in fact occur, it could not have accounted
for a 40 percent increase in oil volume imports. Contacts
familiar with the petroleum refining industry in Thailand
have suggested that the reason for increased oil imports is
that at current prices and refinery margins Thailand is
exporting refined petroleum products to other countries in
the region, although Energy Ministry statistics don't support
this theory. Finally, some say that because the subsidy on
diesel caused fuel to sell for below market prices in
Thailand, some smuggling of product to
neighboring countries took place. The RTG has repeatedly
stated that they expect oil import bills to decline the
second half of the year in response to energy saving measures
and "closing loopholes" in accounting.

11. (SBU) Comment: Most analysts expected the Thai economy to
weaken through the first half of the year (reftels) and they
have proven correct. Now they are anticipating recovery in
the second half. They expect the government's relatively
modest fiscal stimulus, combined with somewhat improved
export performance, a recovery in tourism to tsunami-affected
regions and moderation of imports to bring the current
account deficit down to around US$3 billion by year-end. The
US$2.6 billion net increase of foreign portfolio investment
this year also displays some degree of investor confidence
going forward (although at least some of this is probably
speculation based on Yuan appreciation using the Baht as a
proxy). Finally, bankers tell us that they have seen no
deterioration in loan performance to date. The Bank of
Thailand is carefully monitoring the lending of state-owned
banks to ensure proper credit standards are maintained in the
face of RTG pressure to increase loan volumes. So far, this
pressure seems to be m
ostly talk as part of the government's efforts to reverse
negative public sentiment about economic prospects.

12. (SBU) Nevertheless, we believe that there are significant
risks to the positive scenario; above all the price of oil
which would both further increase Thailand's import bill and
negatively affect Thai export market's ability to grow. If
growth stays below 4 percent for more than another year,
there is a strong likelihood that NPLs would again rise as
companies fail to grow at anticipated rates and restructured
loans return to default status. While we believe banks have
rebuilt their collateral and reserves to levels sufficient to
deal with this problem, the effect on sentiment could
exacerbate current confidence problems.

13. (SBU) There are no discernable bubbles in the Thai
economy, but there are also few signs of robust growth in the
short-term. Consumers will be hit by increases in interest
rates and high energy prices, the real estate construction
boom is slowing and domestic manufacturers still show no
evidence that they are willing to invest in any major
expansion. In 2001 Thaksin was successful in bringing
Thailand back economically through policies that stimulated
domestic consumption while export markets recovered. Now,
Thailand is returning to a period where it must rely on
export markets for growth until RTG infrastructure spending
kicks in. The government is keenly aware of the risks of
overdependence on the performance of other economies in this
"year of adjustment which tests the economy's resilience."
End Comment.
BOYCE

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