RISKY
BUSINESS No room for
Thai complacency By Jephraim P
Gundzik
(Jephraim P Gundzik is president
of Condor Advisers, Inc.)
Political and
social instability have risen rapidly in Thailand
since the beginning of the year. Yet the stock
market is up, and the baht has appreciated over
the past three months. But if Thailand's political
crisis deepens in the months ahead, as seems
likely, it will impact already weak economic
growth.
As investors begin to grasp the
underlying weakness of Thailand's economic and
financial fundamentals, a sharp correction in
equity prices and the exchange rate is likely.
In the first three months of 2006,
Thailand's benchmark SET equity index advanced by
3%, while the baht appreciated against the US
dollar by almost 5%. To a certain extent, the
US$1.8 billion sale of Shin Corp to Singapore's
Temasek underpinned the
rise
in both the stock market and exchange rate. That
has contributed to a certain complacency among
foreign and domestic investors about growing
political and social instability and the adverse
impact this will ultimately have on economic
growth.
This casual attitude seems to stem
from widespread perceptions that Thailand's
current political crisis will soon blow over. This
dovetails nicely with another widely held
perception - that the underlying economic
fundamentals will override political and social
instability, allowing economic growth to
accelerate even faster in 2006.
But
Thailand's political crisis has deep roots. From
the outset, Prime Minister Thaksin Shinawatra has
repeatedly ruffled the political opposition as
well as Thai civil society organizations with
questionable ethics and heavy-handed policies
aimed at shoring up his political power.
In the past several months, a growing
segment of Thailand's urban-based electorate has
begun to take issue with the premier's
questionable policies and autocratic tendencies.
This part of the electorate is made up of mostly
educated and relatively wealthy Thais.
In
contrast to this growing and increasingly
vociferous upper and middle class opposition,
Thaksin continues to enjoy strong support from his
primary constituency - poor and rural Thais. This
constituency, which Thaksin has in recent years
courted with populist pump-priming policies, has
been essential to his political fortunes over the
past five years. Due to this strong rural support
base, Thaksin can stake a major claim to political
legitimacy, even as his political opponents are
vying to bump him from power through
extra-constitutional means.
Both sides in
this struggle for political supremacy have deep
popular support and have demonstrated their
ability to marshal large-scale social action. More
significantly, both sides have thrown down the
gauntlet - Thaksin when he dissolved parliament
and called snap elections, and the opposition when
it called for a boycott of those same polls. The
April 2 general election will not settle
Thailand's political crisis. More likely it will
drag on for months.
Parallels with
Venezuela Thus far, competing pro and
anti-Thaksin demonstrations have been peaceful.
This could change if Thailand's political conflict
degenerates into a class conflict - pitching rural
against urban dwellers. The rural poor could
easily be coaxed, or paid, into fighting for the
political patronage Thaksin has heaped on them. At
the same time, the urban rich could be enticed to
fight for the return of their democratic rights.
Venezuela offers an interesting example of
how the situation could quickly degenerate into
class conflict. Like Thaksin, populist promises
aimed at the rural poor vaulted Venezuela's
President Hugo Chavez to political power. Also
similar to Thaksin, Chavez used this rural support
base as a springboard for consolidating his own
political power while employing autocratic
policies to weaken the political opposition.
These tough tactics eventually produced a
violent class conflict in Venezuela, pitting the
pro-Chavez rural poor against the anti-Chavez
urban rich - a damaging conflict that has only
recently ebbed after raging between 2001 and 2004.
The anti-Chavez opposition in Venezuela
had both political and popular constituencies,
which enjoyed strong support from the country's
corporate sector and media. This support
emboldened the anti-Chavez opposition to mount
large-scale strikes and even coup attempts. The
resulting political and social instability
eventually prompted Venezuela's economy to
collapse. Violent class conflict is not impossible
in Thailand, and Thaksin's divisive tactics
increasingly seem to be pushing the country in
that direction.
Economic blowback Increasing political and social instability
will eventually wreak havoc on Thailand's already
slowing economic growth. According to statistics
from Thailand's National Economic and Social
Development Board, real GDP growth slowed to 4.5%
in 2005 from over 6% in 2004. Only the very strong
growth of public sector consumption and
investment, which effectively helped to offset the
economic impact of the December 2004 tsunami,
prevented real GDP growth from slowing further in
2005.
Export growth, far and away the main
engine of Thailand's economy, slowed to 15% in
2005 from 22% in 2004. Last year slowing exports
combined with surging imports produced trade and
current account deficits of $8.6 billion and $3.7
billion respectively. Preliminary Bank of Thailand
data report a $388 million trade deficit in
January this year. Rising international oil prices
accounted for about 40% of total import growth and
pushed up core inflation from 2.7% in 2004 to 4.5%
in 2005.
Rising inflation and interest
rates undermined private consumption and
investment in 2005 and will continue to dampen the
economy in 2006. Combined with increasing
political and social instability, higher rates
will push private consumption and investment even
lower this year. Meanwhile, increasing instability
will sap private consumption by making Thais less
confident and secure about the future. Instability
will have an even more dramatic negative impact on
private investment, for which stability is
crucial.
In addition to faltering domestic
demand, weakening external demand and increasing
export competition from China are likely to put a
another brake on Thailand's export growth. The
slowdown in export growth in 2005 was paced by
weakening exports of low value-added technology
goods, which advanced by only 17% after surging
27% higher in 2004. The primary factor that slowed
Thailand's technology exports in 2005 was rapidly
growing export competition from China.
Higher international oil prices, which
could exceed $100 per barrel as North American
demand peaks around July, will inevitably push US
inflation and interest rates higher. This could
lead to a sharp slowdown in global economic growth
during the second half of the year, further
undermining demand for Thai exports.
Faced
with these external conditions, it will be
difficult for Thai export growth to exceed 10% in
2006. With export growth continuing to slow and
rising oil prices keeping import growth buoyant, a
further significant deterioration in Thailand's
balance of payments is probable throughout 2006.
In 2005, strong foreign investment flows
provided more than adequate funds to finance the
current account deficit. Net foreign direct
investment reached $3.3 billion - the highest
level since 2001. But alarmingly, net foreign
portfolio investment soared to $4 billion and
short-term external borrowing by Thailand's
private sector jumped by nearly $5 billion. The
last time net foreign portfolio investment and
short-term external borrowing increased by such
magnitudes was in 1997 - the year before capital
flight induced the devaluation of the baht,
provoking a crippling economic recession.
With political, social and economic
fundamentals all deteriorating, strong foreign
investment and short-term external credit are
unlikely to be sustained in 2006. Of course, net
foreign direct investment figures will be
bolstered by the controversial one-off Shin Corp
transaction. More broadly, however, net foreign
portfolio investment could easily reverse as
investor perceptions realign with Thailand's
political, social and economic realities.
The recent court ruling that resulted in
scrapping the planned initial public offering of
the state-owned electricity generating monopoly
EGAT Plc, scheduled to be Thailand's largest-ever
listing, has already dampened investor perceptions
about the country's economic reform trajectory.
And questions are looming about the viability of
Thaksin's earlier plans to spend $38 billion for
new infrastructure over the next five years now
that he is embroiled in political conflict. These
combined factors will arguably produce a
significant correction in Thai stocks later this
year.
These realities will also make it
difficult for Thailand's private sector to roll
over its mounting short-term external liabilities,
which amounted to $17 billion, or 33% of total
external debt at the end of 2005. With foreign
inflows increasingly scarce in 2006, Thailand will
be forced to draw down its foreign exchange
reserves by as much as $15 billion to finance net
outflows of foreign portfolio investment and its
larger current account deficit. This implies that
a significant depreciation of the baht is probable
in 2006.
Baht depreciation could be
intensified by domestic capital flight if concerns
arise about possible capital controls. In May
1997, the Bank of Thailand implemented capital
controls to contain building devaluation pressure
on the baht. These measures severely limited the
ability of Thais to shelter assets offshore in
foreign currencies.
In July 1997, the baht
was devalued by 20% and by the end of that fateful
year the depreciation of the baht against the US
dollar exceeded 80%. As Thailand's political and
social crisis deepens in the months ahead, and
with it confidence in the economy, a new financial
and balance of payments crisis cannot be ruled
out.
Jephraim P Gundzik is
president of Condor Advisers, Inc. Condor Advisers
correctly forecast Thailand's exchange rate
devaluation in 1997.
(Copyright 2006
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