KBank fx & rates strategies the shortest distance between two points is a straight line


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or so they say. Low USD dollar liquidity is a cue for the rise in USD/THB volatility
„ As we are in the year of the Rabbit, the markets will tend to be jumpy…with events in Tunisia and Egypt again highlighting USD perceived safe haven stature
„ Resumption of political activities following end of emergency decree is giving a good excuse for foreign investors to take some money off the table
„ …and reintroduces more uncertainty in the USD/THB picture
„ Our main theme for USD/THB downside remains unchanged…but our 4Q11 USD/THB target is scaled back to 29.00 from 28.00
„ Indications from the central bank along with its perceived preference for a less stronger baht coupled with rising commodity prices prompts us to revise up our 4Q11 BOT repo target to 3.25% from 2.75%

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KBank fx & rates strategies the shortest distance between two points is a straight line

  1. 1. .Mean S FX & Rates Strategies KBank Economics / Strategy The shortest distance between two points is a straight line FX / Rates 31 January 2011 …or so they say. Low USD dollar liquidity is a cue for the rise in USD/THB volatility Kobsidthi Silpachai, CFA As we are in the year of the Rabbit, the markets will tend to be kobsidthi.s@kasikornbank.com jumpy…with events in Tunisia and Egypt again highlighting USD perceived safe haven stature Resumption of political activities following end of emergency decree is giving a good excuse for foreign investors to take some money off the table …and reintroduces more uncertainty in the USD/THB picture Our main theme for USD/THB downside remains unchanged…but our 4Q11 USD/THB target is scaled back to 29.00 from 28.00 Indications from the central bank along with its perceived preference for a less stronger baht coupled with rising Disclaimer: This report commodity prices prompts us to revise up our 4Q11 BOT repo must be read with the Disclaimer on page 14 target to 3.25% from 2.75% that forms part of it KBank Capital Market Research can now be accessed on Bloomberg:Fig 1. Theme Chart…30 day USD/THB vols KBCM <GO> % 8 K-BIZ Contact Center 7 0 2888 8822: For all financial & business 6 inquiries 24 Hours 5 Service 4 3 2 1 0 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 30 day volatilitySource: Bloomberg, KBank111
  2. 2. Yesterday’s darling might be today’s out of favor child2010 was a great year for the Thai baht gaining about 11.07% against the USD. Thecurrency was ranked fourth after JPY, AUD and MYR. That is looking into the rear viewmirror. Looking in front passed the windshield with the year of the Rabbit in full swing, theUSD/THB currency has proved so far to be as jumpy as the rodent. Fig. 1 shows that 30day vol has picked up tremendously to around 6.7%. The Thai stock market, SET, gainedabout 48% in 2010 is prompting investors to take some money off the table. Hence,looking at the following statistics, foreign investors have sold about USD 904 mn, YTD,the most in the region.Fig 2. Foreign Institutional Investment in Regional Equities Day WTD Net MTD Net YTD Net YTD Net As of (Mil US$) (Mil US$) (Mil US$) (Mil US$) YoY% India 94.1 136.8 -755.0 -755.0 -224.0 1/25/2011 Indonesia -28.6 120.1 -419.1 -419.1 -951.2 1/28/2011 Japan 222.1 222.1 7,344.2 7,344.2 -60.3 1/21/2011 Philippines 0.6 24.7 -68.2 -68.2 -260.4 1/28/2011 S.Korea -123.7 -74.5 -74.5 -74.5 -112.3 1/28/2011 Taiwan 303.2 1,308.4 3,438.8 3,438.8 13,617.8 1/28/2011 Thailand -23.4 -80.8 -904.2 -904.2 -298.6 1/28/2011 Vietnam 6.8 13.5 50.4 50.4 175.0 1/27/2011 Pakistan 0.4 5.2 61.0 61.0 317.5 1/27/2011Source: BloombergIt is not rocket science that resumption of rainbow political activities, post the end of theemergency decree is giving a good excuse to take profits from Thailand and rotate itelsewhere in the region. The political implosions in the likes of Tunisia and Egypt willbring back memories of the recent past of the Bangkok events in the middle of last yearand hence, a growing distaste for Thai financial assets. The risk premium is a tad higher,suggesting that the financial markets are expressing a sense of unease. Amidst growingrisk averse coupled with a tight USD liquidity environment, the upward move in theUSD/THB is accentuated further. The next levels for the USD/THB is to test its 200 daymoving average at around 31.19.Fig 3. Thai 5yr credit default swap…a gauge of risk Fig 4. USD/THB: 30, 60, 200 day moving averagespremium bps over Libor Thai CDS 5Y 38 190 37 36 170 35 34 150 33 32 130 31 110 30 29 90 28 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 70 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 USD/THB 30 day avg 60 day avg 200 day avgSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank222
  3. 3. Unfolding events prompt a rethink There is a saying that “the shortest distance between two points is a straight line”. The reintroduction of the Thai risk premium in light of the idiosyncratic political characteristic complicates our call for a USD/THB target of 29.00 by 4Q11. We have taken notice that the central bank’s stance on FX intervention as toughened since mid November. Fig 5 shows that foreign portfolio flows have been instrumental accentuating the moves in USD/THB. The data points include USD/THB versus the sum of foreign flows on Thai equities and fixed income securities with the latter being larger. Based on statistics, correlation between USD/THB and foreign investment flows up to mid November were highly correlated up to 97%. The breakdown in the relation became more obvious post mid November. Fig 7 shows our estimate that in December 2010 the Bank of Thailand most likely bought an additional USD1.9 bn in excess of the balance of payments to steer the USD/THB in a new direction. This could be a game of “chicken”. The name might sound childish but it actually is an important concept in economics…primarily game theory. Fig 5. Relationship between USD/THB & foreign Fig 6. Relationship between USD/THB & foreign portfolio flows (equity & fixed income) Jan to Nov 2010 portfolio flows (equity & fixed income) Jan 2010 to now 250 29.0 400 27 29.5 350 200 28 30.0 300 FX intervention was stepped correlation was nearly 98% between 250 up causing a break in pattern 29 150 Jan 2010 to mid Novebmer 2010 30.5 31.0 200 30 100 150 31.5 31 100 50 32.0 50 32 32.5 0 0 33 33.0 1- 2- 3- 4- 5- 6- 7- 8- 9- 10- -50 1- 2- 3- 4- 5- 6- 7- 8- 9- 10- 11- 12- 1- -502010 2010 2010 2010 2010 2010 2010 2010 2010 2010 33.5 2010 2010 2010 2010 2010 2010 2010 2010 2010 2010 2010 2010 2011 sum of foreign equity / fixed income flows USD/THB, right axis, inverted sum of foreign equity / fixed income flows USD/THB, right axis, inverted Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankFig 7. Thai balance of payments, FX reserves and estimated FX intervention levels USD mn Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Exports fob 13,610.4 14,254.7 16,083.8 13,831.7 16,434.7 17,876.5 15,475.1 16,291.6 17,954.9 17,045.5 17,584.0 17,220.0 Imports cif -13,041.9 -13,801.8 -15,082.1 -14,032.5 -14,143.7 -15,334.2 -16,266.3 -15,439.8 -14,712.2 -14,772.9 -17,093.8 -15,911.0 Trade Balance 568.5 452.9 1,001.7 -200.8 2,291.0 2,542.4 -791.3 851.7 3,242.7 2,272.7 490.2 1,310.0 Current Account Balance 2,107.6 1,655.9 1,779.9 -299.2 1,164.0 820.9 -1,000.8 280.5 2,767.0 2,739.6 1,019.0 1,750.0 Capital and Financial Account Balance 2,743.4 -698.6 1,732.6 2,964.5 -2,607.8 741.2 2,979.8 3,205.9 1,125.8 2,404.6 Overall Balance of Payments 4,965.5 119.3 3,137.3 3,749.0 -989.3 2,166.4 1,412.2 3,589.4 4,269.8 5,821.7 820.3 2,263.0 FX Reserves 142,403.5 141,797.5 144,094.1 147,588.1 143,518.6 146,759.2 151,524.7 155,186.8 163,235.3 171,061.6 167,973.9 172,128.9 Change in FX Reserves 3,985.9 -606.0 2,296.6 3,494.0 -4,069.5 3,240.6 4,765.5 3,662.1 8,048.5 7,826.3 -3,087.7 4,155.0 Estimated intervention -979.6 -725.3 -840.7 -254.9 -3,080.2 1,074.2 3,353.3 72.7 3,778.7 2,004.6 -3,908.0 1,892.0Source: CEIC, BOT, KBank 33 3
  4. 4. The popular source of cyber knowledge, “Wikipedia” defines and discusses “chicken” asfollows: The game of Chicken, also known as the Hawk-Dove or Snowdrift game, is an influential model of conflict for two players in game theory. The principle of the game is that while each player prefers not to yield to the other, the worst possible outcome occurs when both players do not yield. The name "Chicken" has its origins in a game in which two drivers drive towards each other on a collision course: one must swerve, or both may die in the crash, but if one driver swerves and the other does not, the one who swerved will be called a "chicken," meaning a coward; this terminology is most prevalent in political science and economics. The name "Hawk-Dove" refers to a situation in which there is a competition for a shared resource and the contestants can choose either conciliation or conflict; this terminology is most commonly used in biology and evolutionary game theory. From a game-theoretic point of view, "Chicken" and "Hawk-Dove" are identical; the different names stem from parallel development of the basic principles in different research areas. The game has also been used to describe the mutual assured destruction of nuclear warfare, especially the sort of brinkmanship involved in the Cuban Missile Crisis. The game is similar to the prisoners dilemma game in that an "agreeable" mutual solution is unstable since both players are individually tempted to stray from it. However, it differs in the cost of responding to such a deviation. This means that, even in an iterated version of the game, retaliation is ineffective, and a mixed strategy may be more appropriate.In 1997, the Bank of Thailand and hedge funds had locked horns in a game of “chicken”,with the hedge funds shorting the baht while the Bank of Thailand bought baht to defendthe peg. As bystanders became more biased towards the hedge funds, the defensecrumbled since the peg was built on a house of cards with the odds stacked against theThai central bank such as the long list of imbalances: persistent current account deficits, rising financial leverage, land / real estate speculation, mounting short term foreign currency debt facilitated by the Bangkok International Banking Facilities (BIBF), Thai firms conducting interest rate arbitrage by issuing euro convertible debentures (ECDs) encouraged by the fallacy of no FX exchange risksFor the present situation, it looks like luck has sided with the central bank as the foreignflows are swerving into outflows. By stepping up the FX intervention, foreign investorswere discouraged from aggressively putting more money into the Thai markets sincelosses on FX will reduce their returns on the financial assets i.e. local currency capitalgains and interest rate differentials.We agree that FX intervention and sterilization should be conducted on foreign portfolioflows since by not doing so, Thai juristic and natural persons would becomeunconsciously indebted to foreign funds, since we do not have the funds’ ownership.Conversely, the point that we have consistently stressed is that flows belonging to Thaijuristic and natural persons i.e. current account flows should not be intervened for thefollowing reasons: It represents a cross subsidy between the external side and internal side of the economy i.e. exporters gain at the expense of the general population444
  5. 5. …correspondingly, it facilitates wealth concentration. Said another way: “Spread the pain and concentrate the gains” Supports moral hazard as Thai exporters would be discouraged from improving on productivity and quality for gaining a competitive advantage and continue to look to the Bank of Thailand to be competitive based on price function alone.Egyptian events is a reminder of the Iranian RevolutionWhile Egypt is not a member of OPEC, it proves to be critical to the global economy. Twocanals are vital to global trade, one is the Panama canal linking the Atlantic to the PacificOcean and the other is the Suez Canal in Egypt. It is said that the Suez Canal cutsshipping distances by about 6000 miles. Should the social unrest cause the closure of thecanal, shipping between Europe and Asia would be disrupted, causing spiraling logisticcosts, shortages of goods and services and eventually exporting inflation through out theworld.The Iranian Revolution was a regime change from a Monarchy to an Islamic Republic.The protest disrupted oil production and resulted in the second oil shock. Note that today,Iran is the second largest OPEC producer after Saudi Arabia.The jump in oil prices is an ill omen for the baht as Thailand is one of the lesser oilefficient countries in the region given the lack of logistic developments with some railwaysdating back to possibly WWII. With Thai logistics still depended on trucks and hencediesel, the jump in crude can only mean higher demand for USD/THB to settle for oilimports, at least for the short-term.Fig 8. Suez canal Fig 9. First and Second Oil Shock 45 40 35 30 second oil shock 25 first oil shock 20 15 10 5 0 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 Crude oil, Asia, USD / barrelSource: Central Intelligence Agency Source: Bloomberg, CEIC, KBank555
  6. 6. We are scaling back our USD/THB targets: 29.50 for 2Q11 and 29.00for 4Q11The new stance expressed by the Bank of Thailand on FX management reflects a morehands on style, being more aggressive in limiting the USD/THB downside and morelenient on the capping the USD/THB upside. This is a significant change from what wesaw for the earlier part of 2010. With consideration to these points, we are scaling backour targets for USD/THB and revising them to: 29.50 for 2Q11 29.00 for 4Q11Fig 10. KBank USD/THB model Fig 11. USD/THB Fibonacci levels KBank USD/THB model 48 34 46 33 44 42 32 40 31 38 36 30 34 29 32 30 28 28 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 01 02 03 04 05 06 07 08 09 10 11 12 USD/THB Min Max 23.6% actual model 38.2% 50.0% 61.8% 76.4%Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankWe have not changed our major thesis for the USD/THB. The risk of the USD has beentemporarily dismissed from the markets for the time being. Japan’s sovereign downgradefrom AA to AA- by Standard & Poor’s is an attestation that countries can not go onforever without fiscal discipline. Greece is a reminder and so as with the rest of the PIIGSin the Eurozone. Beside the US Federal Government, the growing concern with the US(the United States) is with the state and local governments’ ability to keep themselvesafloat amidst mounting debt. The following function in Bloomberg (MIFA <GO>) showsthat the likes of California, Texas, New York are experiencing ever larger deficits. Thismeans the Fed is unlikely to shift its ultra accommodative monetary policy anytime soon(please see the annex to the FOMC’s recent statement). More US dollars can eventuallyonly mean lower prices.Fig 12. The arguments for and against USD/THB directions USD/THB positives USD/THB negatives Resumption / escalation of political unrest, which Current account surpluses of Thailand, meaning, prompts a more extended outflows of foreign portfolio exporters outnumber importers. This is a result of flows out of Thailand irregularities in the Thai political and social landscape Increasing probability that the Eurozone breaks up, which thwarted domestic demand hence reallocation of foreign currency reserves back Expectation of further USD/CNY downside as to to the USD supplement the fight against inflation Service account outflows from SET dividend Continued Fed accommodative monetary policy, repayments / Japan fiscal year closing meaning more USD, lower USD price Better economic growth prospects in Asia relative to the West Political clarity on Constitutional amendments and general elections Return of Thai portfolio flows e.g. from Korean bondsSource: KBank666
  7. 7. Fig 13. The USA or USB, the United States of BankruptcySource: Bloomberg, KBank Federal Open Market Committee (FOMC) Statement January 26, 2011 Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer term inflation expectations have remained stable, and measures of underlying inflation have been trending downward. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow. To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury777
  8. 8. securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset- purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate. Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.Playing “chicken” with inflation?Economics is the study of opportunity costs and hence any decisions taken by economicagents will incur a trade off. The inconsistency in monetary policy of pricing baht withrespect to other currencies (FX exchange rates) and with respect to time (interest rates)might be causing more problems than it solves. The riots in Tunisia and Egypt is said tobe partly attributable to rising inflation. In layman’s term, inflation simply means that oneis getting poorer as to oppose to getting gaining prosperity.The rise of China in the global economy is proving to more like a double edge sword. Onthe positive side, it is serving as a large production base as well as becoming a largemarket for goods and services. On the other hand, it is clear that the planet is beingstrained to supporting a population with over 1.36 billion with growing wealth of nearly10% a year.Coupled with more frequent supply shocks from nature i.e. floods, drought, diseases, it isno wonder as to why the prices of commodities, whether it is metals, energy oragriculture have consistently climb. Fig 14 shows that before the fall of Lehman Brothers,there is a high correlation between China’s nominal GDP and the CRB (CommodityResearch Bureau) index of 19 commodities including agriculture, energy and metals.Fig 14. China’s nominal GDP & CRB commodity index Fig 15. Not just coincidence CRB index 100000 500 500 90000 450 80000 450 70000 400 y = 0.0044x + 121.16 400 60000 350 2 R = 0.8826 50000 350 40000 300 30000 300 250 20000 250 from Dec 99 to Jun 08 200 10000 0 150 200 99 00 01 02 03 04 05 06 07 08 09 10 150 10000 20000 30000 40000 50000 60000 70000 CH nominal GDP 4Q moving sum, CNY bn, left CRB index, right CH nominal GDP, CNY bnSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank888
  9. 9. Fig 16. …neither is this: China’s nominal GDP & Thai Fig 17. …as well as explaining a lotCPI TH CPI index 100000 115 115 90000 110 80000 110 y = 0.0004x + 77.118 70000 105 2 R = 0.9389 105 60000 100 50000 100 40000 95 30000 95 90 20000 90 85 10000 0 80 85 00 01 02 03 04 05 06 07 08 09 10 80 10000 20000 30000 40000 50000 60000 70000 80000 90000 100000 CH nominal GDP 4Q moving sum, CNY bn, left TH CPI index, right CH nominal GDP, CNY bnSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankThe question is, how can an increase in Thai policy rates control Thai inflation if inflationis more of a function of regional supply and demand rather than just Thai supply anddemand? After all this is by design via all the Free Trade Agreements sign for regionaleconomic integration. Fig 17 shows that size of the Chinese economy has a largeinfluence on Thailand’s inflationary environment.So, it seems that by playing “chicken” with portfolio flows, the central bank is also playing“chicken” with inflation. By allowing the baht to weaken amidst rising commodity prices,the transmission of imported inflation will be much more rapid.The Bank of Thailand’s recent inflation report strongly indicates a fear of rising inflationand that core inflation might get out of hand if interest rates remained low. The followingtable is the probability distribution for core inflation going forward. With the assumptionthat the repo remains at 2.25%, there is a 43% probability that core inflation will exceedthe 3% upper band in 3Q11 and a 55% probability for 4Q11.Fig 18. BOT Inflation Report, Core CPI probability distribution Ranges: % 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 >3 0% 12% 43% 55% 11% 6% 3% 3% 2.5 3.0 2% 26% 31% 28% 24% 17% 11% 11% 2.0 2.5 22% 34% 19% 13% 32% 31% 25% 26% 1.5 2.0 51% 21% 6% 3% 23% 29% 32% 32% 1.0 1.5 23% 6% 1% 0% 8% 13% 21% 20% 0.5 1.0 2% 1% 0% 0% 2% 3% 7% 6% <0.5 0% 0% 0% 0% 0% 0% 1% 1%Source: BOT Inflation Report, Jan 2011The major source of unease for the central bank is that economic growth has closed theoutput gap. In layman’s term, fig 19 shows what an output gap is. If the actual growth isabove trend (in this figure, it is a simple best fit regression line), it suggests that theoutput gap has closed, meaning that there is little slack left in the production side. Thiswould then indicate that the pass through of inflation (the depreciation rate of money)would be more readily transmitted. A case in point is our current problem with palm oil. Ifthere is not enough slack on the supply side, there will not be enough goods to go aroundand prices have to rise anyways. Actually price ceilings might exacerbate the problem asblack markets form where the price sold is higher than the price ceiling.999
  10. 10. Fig 19. Output gap has closed Fig 20. KBank BOT repo model 5,000,000 % 6 4,500,000 5 4,000,000 above potential growth 4 3,500,000 3 long term trend 3,000,000 2 below potential growth 2,500,000 1 2,000,000 0 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 01 02 03 04 05 06 07 08 09 10 11 12 Thai GDP, 1998 price, 4Q moving sum Linear (Thai GDP, 1998 price, 4Q moving sum) actual modelSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankWe have inputted the assumptions suggested by the BOT Inflation Report which webelieve that the MPC also believes in these assumptions, after all, BOT scholarships arenot cheap and easy to come by. Fig 20 shows our repo model which is a behavioralmodel. Simply it gauges how the MPC responds to key economic data points (e.g. growthand inflation) as reflected in the repo rate. With the new assumptions, we view that theBOT is likely to take policy rates up to 3.25% by the end of the year, as opposed to ourearlier call of 2.75%. The release of the MPC minutes (the first ever) shed a lot of light oftheir concerns for growing potential financial imbalances. Minutes of the Monetary Policy Meeting of the Monetary Policy Committee Bank of Thailand 12 January 2011 Publication date: 26 January 2011 Members Present Prasarn Trairatvorakul (Chairman and Governor), Atchana Waiquamdee (Vice Chairman and Deputy Governor, Monetary Stability), Suchada Kirakul (Deputy Governor, Corporate Support Services), Ampon Kittampon, Praipol Koomsup, Siri Ganjarerndee, Krik-krai Jirapaet Financial Markets The Thai baht was volatile, appreciating relative to the US dollar on the back of capital inflows while depreciating in the beginning of 2011 due to sales of equity by foreign investors after better-than expected US economic data. Going forward, investors are expected to give greater weight to recovery in major countries, resulting in greater two-way movement of the baht as opposed to continued appreciation pressure observed in the previous year. In addition, the yield curve shifted slightly upwards following the previous MPC meeting reflecting market pricing of an interest rate hike this meeting. The majority of market participants surveyed expected the current MPC meeting to result in a rise in the policy rate by 0.25 percentage points while some expected an overall rise of 0.50-1.00 percentage points in 2011. International Economic Conditions Risks to global economic growth have fallen. The US economic recovery continued to strengthen. A survey of economists indicated that the majority viewed that the US economy would grow faster than forecasted and that employment would improve although risks from house prices remained. Nevertheless, certain MPC members expressed concerns regarding the continually high rate of unemployment. The European economy stabilized although money markets remained volatile due to concerns over sovereign debt. However, core member countries, especially Germany, are projected to become101010
  11. 11. drivers of growth. The Japanese economy still faced deflation while the appreciating yen may impede growth going forward. The Asian economy continued to grow on the back of domestic demand and exports destined to both within the region as well as new markets with high growth potential. Overall, the region is becoming less reliant on the G3 economies. However, the risk to inflation for the region as a whole increased significantly. The uneven growth of advanced economies and emerging markets has led to varied monetary policy responses. Advanced economies pursued accommodative monetary policy to safeguard economic recovery while emerging markets tightened to maintain price stability and are expected to accelerate the pace of interest rate normalization in 2011. As a result, challenges for Asia going forward are likely to come from capital flow volatility and the appropriate pacing of monetary policy tightening. Domestic Economic Conditions Thai economic growth was projected to return to its long-term trend. The Thai economy continued to expand in Q4 of 2010 from the previous quarter in line with domestic and external demand. Going forward, growth will be supported by 1) private consumption expansion on the back of both agricultural and non- agricultural income, increase in the minimum wage, low unemployment and robust consumer confidence and 2) private investment, which despite some slowdown after accelerating in the prior period, should expand going forward due to favorable business confidence, high capacity utilization in many industries, and future investment plans to meet internal and external demand for goods in services and 3) fiscal stimulus from government income support programs for mostly low-income earners and government investment for both large projects and state enterprises which was expected to increase from the previous year. Export growth in the previous year exceeded expectations and was expected to continue its growth trend into 2011 due to Chinese and ASEAN economic expansion as well as the rising trend in advanced orders. In addition, various research houses projected strong export growth in 2011 supported by a rising export prices (except for fisheries where there is low pricing power) which was expected to partly mitigate the adverse effects of baht appreciation. Tourism activity was solid and was expected to expand going forward. In the monetary sector, private credit expanded well together with overall economic growth. The expansion in commercial bank credit was primarily due to demand from households. Corporate loans also increased and were projected to grow continuously in 2011. Commercial banks rapidly raised both deposit and loan rates following the policy rate hikes. In regards to price stability, inflation pressure increased from the previous period. Headline inflation accelerated in line with the rise in wages while core inflation picked up due to the pass-through of production costs into goods prices, especially prepared food and seasonings and condiments. The MPC assessed that inflation pressure going forward has increased due to both cost-push and demand pull factors. Cost-push factors include: 1) upward trend in oil and commodity prices on the back of global economic expansion; 2) increased pass- through from the Production Price Index (PPI) into Consumer Price Index (CPI) as authorities allowed price increases in many product categories; and 3) gradual pass-through of production costs to consumers as producers’ ability to absorb such costs became more limited. Demand-pull factors include: 1) a diminishing output gap as output growth neared potential while producers have revised their inflation expectations upwards for some time. These factors would speed up price adjustment going forward. In addition, some MPC members expressed concerns over the possibility that inflation may breach its target this year.111111
  12. 12. Considerations for Monetary Policy. The MPC viewed that the risk to inflation had increased relative to the risk to growth compared to the previous meeting. The global economic recovery strengthened compared to the previous meeting. The risk of a double dip recession in the US declined while Asia faced the challenge of rising prices, particularly those of commodities. The Thai economy continued to return to its long-term growth trend. The MPC viewed that domestic demand would become the principal driver of growth in the coming period. In addition, strong export performance pointed to Thailand’s economic resilience in face of the baht appreciating in the previous period. Inflationary pressure clearly increased due to rising oil and commodity prices, the return of the Thai economy to its long-term growth trend and pent-up pressure from delayed price adjustments. At the same time, increases in the minimum and civil service wages may boost consumption expenditures more than expected and lead to a rise in inflation expectations going forward. Some MPC members were concerned that low real interest rates may foster financial imbalances, depress savings and lead to asset bubbles in the future. MPC members were unanimous in seeing the need to maintain continuity in signaling rate normalization. Robust economic expansion together with significantly increased inflationary pressure led to some members discussing the possibility of a rate hike of 0.5 percentage points. Nevertheless, the majority of MPC members viewed that policy rate adjustment should be gradual while taking into account that the neutral rate depends on changing economic circumstances. The MPC therefore decided unanimously (7 to 0) to raise the policy interest rate by 0.25 percentage points per annum, from 2.00 to 2.25 per cent per annum, effective immediately.121212
  13. 13. Fig 21. Monthly Key Economic Indicators May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Nov 10 Dec 10Manufacturing index 185.0 194.2 190.1 183.7 201.5 191.2 190.4 190.2 % YoY 15.9 14.2 13.1 8.4 8.1 6.0 5.7 -2.5Industrial capacity utilization rate (%) 64.3 65.4 64.8 63.6 64.4 63.9 63.6 63.4Retail sales (% YoY) 8.1 11.9 12.5 8.2 9.1 5.1 7.6Passenger car sales (units) 62,205 70,557 65,672 65,724 68,261 72,012 78,874 93,122Motorcycle sales (units) 138,558 168,389 175,926 153,256 147,932 145,916 154,971 154,971Unemployed labor force (000 persons) 586 459 346 353 343 355 390Commercial car sales (units) 1.5 1.2 0.9 0.9 0.9 0.9 1.0Consumer prices (% YoY) 3.5 3.3 3.4 3.3 3.0 2.8 2.8 3.0 core 1.2 1.1 1.2 1.2 1.1 1.1 1.1 1.4Producer prices (% YoY) 8.0 11.5 11.1 10.7 9.1 6.3 5.9 6.7External Accounts (USD mn, unless specified otherwise)Exports 16,435.0 17,877.0 15,475.0 16,292.0 17,955.0 17,046.0 17,584.0 17,220.0 % YoY 42.5 47.1 21.2 23.6 21.8 16.6 28.7 18.6Imports 14,144.0 15,334.0 16,266.0 15,440.0 14,712.0 14,773.0 17,094.0 15,911.0 % YoY 53.6 38.3 36.5 41.8 15.7 14.4 35.0 8.8Trade balance 2,291.0 2,543.0 -791.0 852.0 3,243.0 2,273.0 490.0 1,309.0Tourist arrivals (000) 815 953 1,258 1,268 1,220 1,360 1,500 1,840 % YoY -11.8 -0.2 14.7 12.5 1.9 6.3 10.3 -10.7Current account balance 1,164.0 821.0 -1,001.0 280.0 2,767.0 2,740.0 1,019.0 1,750.0Balance of payments -989 2,166 1,412 3,589 4,270 5,822 820 2,263FX reserves (USD bn) 143.4 147.1 151.5 154.7 163.1 171.1 168.2 172.1Forward position (USD bn) 13.0 12.2 11.0 12.1 11.1 12.6 15.3 19.6Monetary conditions (THB bn, unless specified otherwise)M1 1,261.9 1,180.2 1,173.0 1,181.4 1,175.5 1,202.3 1,235.4 1,235.4 % YoY 14.4 15.1 15.8 11.4 11.7 11.4 10.8 10.8M2 11,001.5 10,846.4 10,887.1 10,968.1 11,116.1 11,322.4 11,497.3 11,497.3 % YoY 6.7 6.9 8.7 8.4 9.8 11.1 11.0 11.0Bank deposits 10,229.1 9,983.3 9,974.5 10,015.9 10,091.6 10,204.1 10,389.3 10,389.3 % YoY 7.0 6.2 7.6 6.6 7.8 8.5 8.1 8.1Bank loans 9,101.2 9,196.7 9,219.7 9,299.8 9,432.7 9,580.5 9,743.9 9,743.9 % YoY 7.3 8.5 9.1 9.8 10.8 12.1 12.2 12.2Interest rates (% month end)BOT 1 day repo (target) 1.25 1.25 1.50 1.75 1.75 1.75 1.75 2.00Average large banks minimum lending rate 5.86 5.86 6.00 6.00 6.00 6.00 6.00 6.12Average large banks 1 year deposit rate 0.68 0.68 0.98 0.98 1.11 1.11 1.11 1.32Govt bond yield 1yr 1.52 1.56 1.91 1.99 2.01 1.98 2.11 2.38Govt bond yield 5yr 3.06 2.99 3.08 2.69 2.56 2.83 2.98 3.26Govt bond yield 10yr 3.49 3.33 3.44 3.01 3.12 3.18 3.59 3.77Key FX (month end)DXY US dollar index 86.59 86.02 81.54 83.20 78.72 77.27 81.20 79.03USD/THB 32.51 32.42 32.26 31.27 30.33 29.91 30.20 30.06JPY/THB 35.67 36.61 37.31 37.18 36.35 37.16 36.11 37.02EUR/THB 39.96 39.79 42.12 39.73 41.31 41.62 39.37 40.18Source: Bloomberg131313
  14. 14. Disclaimer For private circulation only. The foregoing is for informational purposes only and not to be considered as an offer to buy or sell, or a solicitation of an offer to buy or sell any security. Although the information herein was obtained from sources we believe to be reliable, we do not guarantee its accuracy nor do we assume responsibility for any error or mistake contained herein. Further information on the securities referred to herein may be obtained upon request.141414