How Populist Policies left Thailand Mired in Debt

What has gone wrong in the economy for the Land of Smiles? Once the darling of the Asian tigers, some analysts suggest Thailand is stuck in the middle-income trap with improvements in human capital stagnating. In the short term, Thailand has had to cut its 2013 growth forecast as the country entered recession in Q2 2013 when GDP unexpectedly shrank 0.3%. This was the first time since the global financial crisis that the country had entered recession, yet its economy had been slowing down for several quarters as even in Q1 2013 growth was just 1.7%. These results have lead to a forecasted 2.8% economic growth by end of 2013. Previous forecasts were for 5.1% growth, revised down to 4% growth before this latest revision.

Blowing the Populism Trumpet

The main problem is populist policies. The ability of ordinary people to spend has been curtailed, with many obliged to service loans for cars bought under the government’s first-time buyers scheme. The scheme is a tax rebate on first cars promised in Yingluck Shinawatra’s election campaign of 2011, which has had 1.2 million car buyers applying for the refund so far. However, the tax rebate is not the only factor to blame for increased consumer debt; consumer debt has risen sharply since 1997 due to rapid urbanisation, increased presence of loan sharks in the lending system and higher consumer spending. Household debt has risen rapidly from 28% of GDP in 1997 to 63% of GDP in 2010 to 70% in 2011 to 78% in 2012 and 80% currently. Yet the 80% figure still does not take into account informal lending such as by loan sharks. Meanwhile a third of the 80% household debt is derived from consumer finance in the commercial banking system. Moreover, the debt service ratio of 52% of disposable income for low-income earners in 2011 far exceeds the appropriate level of 28-30%, and has grown from 46% in 2009. Low-income earners are classed as those earning less than THB10,000 a month (GDP200). The debt service ratio is the proportion of debt payment to disposable income with a higher ratio indicating more vulnerability to the upward interest rate cycle. The picture was better for those earning more than THB10,000 a month with their debt service ratio being 25%. Despite the high level of household debt, there are no signs of mass default yet. The key factors in mass default would be higher interest rates, living costs exceeding income, and unemployment. Thailand boasts one of the world’s lowest unemployment rates of 0.77%, meaning people generally have enough income to borrow from banks. That there are no signs of mass default is evidenced by non-performing loans in the commercial banking system currently standing at only 2% of outstanding retail lending.

Unable to get the Scissors Out

However, the high household debt limits the scope for the Bank of Thailand to cut interest rates. The Bank of Thailand had cut the policy interest rate from 2.75% to 2.5% a few months ago, which has consequently inhibited economic growth from Q1 2013 to Q2 2013. The cut had originally aimed to cushion downside risk to consumption, yet has not had the intended effect with domestic consumption still slowing. The Bank of Thailand should ideally like to cut the interest rate by 25 basis points as private investment and consumption continue to slowdown – consumption was predicted to grow 6.7% now revised to 3% and private investment by 14.4% now revised to 3.4%. However, cutting the interest rate could have an unintended consequence of opening room for new loan applicants and increased household debt by alleviating the financial debt burden of existing borrowers. It is this factor which is keeping Thailand mired in consumer debt and lacklustre economic growth, as well as forced the Bank of Thailand to hold its policy interest rate at 2.5% at its August 21^st meeting, after Assistant Governor Paiboon Kittisrikangwan said high household debt limited the scope for further easing.

Infrastructure Spending has its Dangers

Another area where debt may be an issue is concerning government debt. Thailand’s government debt is 44% of GDP. Compared with other emerging markets, Thailand’s debt is higher than the average and forecast to increase due to various government infrastructure projects, unlike the average of others. However, compared to developed economies, Thailand’s debt is significantly lower and it is also under the 80% “danger level”. One avenue that Thai policy makers are pursuing to prop up growth is to initiate government spending plans. They are planning to spend THB2 trillion (borrowed from banks) to develop transport in the country with 40% spent on high-speed train networks, 20% to double track rail improvements and 23% to Bangkok’s mass transit systems. The remainder will be allocated to new highway expansion, freight terminals, customs checkpoints at key border crossings and port improvements. This will be hugely beneficial for growth as Thailand’s land transport costs are relatively high, driving the country’s overall logistics costs to 15.2% of GDP or THB1.75 trillion. Land transport now makes up almost 86% of overall transport, wth marine travel 12%, rail 2% and air 0.02%. Given the average cost of transport, land routes cost THB1.72 per tonne per kilometre, rail 93 satang and marine 64 satang. Furthermore, an ill-thought out rice pledge scheme has led the government to waste billions propping up rice farmers throughout the country.

The Flow of Funds Worldwide

Thailand is also targeting amending one of its ministerial regulations in order to better control capital inflows and outflows. After the new rules take effect, the government will be able to issue measures to control capital flows once the Bank of Thailand proposes them to cabinet. These could be both fiscal measures and monetary measures. Existing regulations only allow the government to regulate capital inflows. A mechanism to cub capital inflows and outflows was needed because the government projected a further appreciation of the Thai Baht over the remainder of the year. However, rhetoric from the US Federal Reserve that quantitative easing may end has removed this need. Quite the opposite, Thailand now fear a massive outflow once quantitative easing ends definitively. Massive capital inflows caused by the quantitative easing measures of the USA, the EU and Japan have reached US$5.86 trillion (THB175.8 trillion baht, triple the US$1.85 trillion of inflows during the US financial crisis of 2007-2008. The major concern with the massive capital inflows is that it is not direct investment in real asset sectors but in the bond and stock markets, which could cause volatility and asset bubbles. The new regulation includes allowing unlimited currency exchange for investments in foreign securities and in foreign-currency denominated securities sold in Thailand. Individuals are limited to buying US$1 million worth of foreign currencies a year to send to their relatives overseas. Buying foreign currencies to invest in property overseas is capped at US$10 million a year. More stringent measures may be needed if the currency’s movement either way is too fast. Thailand’s exports were under pressure due to the baht strength, yet this has now been replaced by the danger of a slowdown in demand from China for Thai exports.

What has gone wrong with Thailand’s growth story? Well the short answer is volatility in its exchange rate due to global quantitative easing and rising household and government debt. The four core economic growth engines are public spending, domestic consumption, investment and exports. These are all experiencing challenges currently. Public spending is on the rise with the government set to borrow heavily for infrastructure projects, domestic consumption has been hit by rising household debt, and exports are also under pressure from a slower-growing China. Meanwhile investment is low compared to Thailand’s neighbours with annual growth in foreign direct investment from 2004 to 2012 just 5% compared to 34% in Indonesia, 23% in Vietnam, and 10% in Malaysia. Nonetheless forward-looking indicators suggest both businesses and consumers continue to hold positive sentiments for the economy, a crucial ingredient in any economic growth story.