Will the Subprime Crisis affect Thai economic stability

Although the subprime problem emerged over a year ago, it has not affected Thailand that much. However, many worry that in 2008 the Thai economy will face “double trouble” or the real fallout from this worldwide crisis. In the condition that Thai economy has not recoverd yet, this problem will be a difficult task that the new government’s economic team has to solve it.

As people hold their breaths in anticipation of the impact from the coming subprime tsunami, they are mostly concerned with the repercussions it will have on economic growth. A recession in the American economy will cause a slowdown of the worldwide economy, causing a rebound effect on our own economy, which would also slow. Another area to consider is how the subprime effect will affect Thai economic stability. Here is how I see it.

Internal Stability

If we measure the stability of our domestic economy by measuring changes in the prices of goods as well as the inflation rate, we will not see much action. The subprime problem will not directly affect the domestic inflation rate, but it will affect our economy through two other factors, which are the oil price (Cost Push Factor) and the interest rate (Demand Pull Factor).

Oil prices have dropped since the end of last year, so manufacturing costs have tended to be lower. Then, because the subprime problem is forcing the US into an economic recession, the demand for oil should slow because the USA is the biggest oil consumer in the world. The crude oil price still fluctuate. It sharply dropped from 100 dollars/barrel at the beginning of January to 89.41 dollars/barrel but now incerase to about 95 dollars/barrel.(15Feb)

However, lower oil prices may not decrease the price of goods immediately because manufacturers are still using more expensive inputs they bought while the oil prices were high. Because the cost of inputs increased in the recent past, manufacturers must retain higher price grids to cover their costs. Thai entrepreneurs are still living under the shadow of previous exorbitantly high oil prices; that is, many still are struggling to handle the extra manufacturing costs incurred because of high oil prices. Manufacturing costs do not fall as suddenly or as easily as the oil prices did. Therefore, although oil prices have fallen, the prices of goods and the inflation rate may not decrease much, especially in the first few months of this year.

Interest rates are a different story. They depend on many factors such as economic conditions, policy direction, and international interest rates. In the USA, interest rates were reduced 2 times. The first time 0.75% and then 0.5%. This is because governments and financial institutions scramble to control the subprime problem.

Some people worry that overseas capital will flow into Thailand and appriciate the Baht. Moreover, any pressure to push inflation rate tend to decrease. So, it is anticipated that Thailand will lower its interest rates to stimulate consumption and domestic investment, and to decrease the pressure on the Baht. In addition, because the political situation is more stable at least for now, this should help restore domestic demand, but it may push inflation upwards.

In conclusion, the subprime problem will affect the stability of the Thai economy indirectly through oil prices and the domestic interest rate, thrusting Thailand’s inflation rate even higher than it was last year. Even so, it will not cause inflation to rise to dangerous levels because oil price should fall.

External Stability

External economic stability can be evaluated by looking at the volume of international reserves. These depend on Thailand’s balance of payments, composed of our current account (imports versus exports) and our capital account (inflows versus outflows). If both balances are positive, the amount of international reserves will increase. On the contrary, if the balance is negative, international reserves will decrease.

The capital account balance depends on the movement of net international capital. Capital naturally move to where the return is higher and the return can be considered from interest rate.

Therefore, the decision of America’s Federal Bank (its central bank) to lower its interest rate will mean that interest rates in America will be lower than they are in Thailand, producing a flow of capital moving to Thailand.

The subprime problem will deplete the surplus in the Thai current account because of the slow down in the US Economy and the economies of Thailand’s other trade-partner countries, which will slow Thai exports as well. It is anticipated that export growth will be less than 10% this year, following a decrease of 19% in 2007.

When we add the current account balance with the capital account balance, we can see that the capital account balance will tend to have a greater surplus, whereas, the current account balance will tend to have a lower amount of surplus. The impact of the subprime problem on both accounts, therefore, will counteract each other. Hence, this will not be likely to affect the balance of payments and international reserves that much. According to information released in September 2007, Thailand’s international reserves are as much as 80,000 million dollars, including 6.7 times of short term international debt (IMF’s standard is 1.5 times). Therefore, because of Thailand’s strong reserves, the subprime problem is not likely to affect Thailand’s external economic stability.

However, the subprime problem will affect Thailand’s internal economic stability more than its external stability. However, the impact should not be so serious because the negative and positive factors influencing our economic stability will counteract each other. Nevertheless, the new government needs to make its Monetary and Fiscal policies carefully because of continuing instability in the global economy.

Dr Kriengsak Chareonwongsak
Senior Fellow, Harvard Kennedy School , Harvard University
kriengsak@kriengsak.com, kriengsak.com, drdancando.com