The latest Monetary Policy Committee (MPC) report gave a clear signal that it is considering a potential "rate increase to build policy space". Such a signal would indicate the Thai economy is performing well and inflation remains on target, says Amonthep Chawla, head of research at CIMB Thai Bank (CIMBT).
"The significance of the expansionary monetary policy will fade into the background as the need for a rate hike to provide greater policy space grows," he said.
The term policy space, which refers to the central bank's ability to impose policies in times of need, is of great importance in this economic environment, said Mr Amonthep. Policy space refers to the Bank of Thailand's ability to use expansionary monetary policy to provide stimulus in times of an economic slowdown, he said.
"Most people are asking if Thailand is ready for a rate hike. I would instead ask: 'is the next economic crisis in sight?' The pending crisis I am referring to is not related to a potential rate hike. It is merely part of the business cycle," said Mr Amonthep.
He said the numbers point toward a growth cycle, as the Thai and global economies are growing at higher rates than in recent years, despite the muted effects.
"Given the nature of business cycles, in times of growth, we cannot stand idle but must also brace ourselves for potential slowdowns if not outright crisis because these downturns are hard to predict, with no real patterns such as that of the 1997 or 2008 economic crises," said Mr Amonthep. "On top of protecting ourselves from said crises, we must equip ourselves with responsible monetary policies to defend ourselves in the face of severe economic downturns."
Vaccinating the Economy
He said while a rate hike is a "necessary step" as it fends off high-yield seeking investors and discourages irresponsible risk management, the hike will raise overall costs for both businesses and consumers.
"The rate's effects on the economic recovery are likely to be manageable as we are operating on the positive side of the business cycle with high levels of business revenue and consumer income," said Mr Amonthep. "This hike is like a vaccination -- it's going to sting a little, but it's a necessary pain for our future economic well-being. So why isn't the central bank 'vaccinating' the economy?"
He said the Thai economy is not strong enough to handle this vaccine.
"Hiking rates in the previous period would have been similar to vaccinating a fragile patient -- instead of protecting the economy, the rate hike infects it with an economic slowdown," said Mr Amonthep. "The growth we have seen thus far has been severely uneven -- small businesses and low-income earners did not see a substantial rise in revenue or income, while household debt remains high. As such, if interest payments rise, disposable income will take a hit and consumer's purchasing power will sink despite the positive growth outlook."
He said the key prerequisite for a rate hike is all-around positive economic growth.
"We expect that it will take at least six months for the agricultural sector to see increasing revenue from price rebounds and growth in the non-agricultural sector from higher private investment and longer working hours. If growth occurs as expected, we will see a spread in purchasing power toward other provincial areas rather than a concentration in Bangkok," said Mr Amonthep.
But while he does not forecast a rate hike this year, he does think there will be one next year.
How much is enough?
"Let us take a step back, not to the rate hike but to policy space -- how much 'space' are we talking about in times of economic crisis," said Mr Amonthep. "Imagine for instance that we see a global economic slowdown in 2020 driven by the US's lagging growth at less than 1%. This could be driven by, say, the US's decision to stabilise budget deficit by cutting down on fiscal spending because of President Donald Trump's recent decision to cut corporate taxes. As such, Thailand's economy is adversely affected as overall export declines while there is an increase in overall volatility in the global financial markets."
He said that while such a scenario would not drive down growth to negative levels, it could be strong enough for the MPC to lower rates to stimulate the economy and inject liquidity into the financial markets.
If the MPC is pushed to lower the rate in the next two years, even if the Bank of Thailand cuts the rate to nothing, a situation which Mr Amonthep described as "impossible" for an emerging economy like Thailand's, there would only be a rate decrease of only 1.5%.
"This may suffice for a moderate crisis -- such as that of the dotcom bubble -- but no where near adequate for a larger-scale crisis, as the 2008 global financial crisis, when the MPC lowered overall rates from 3.75% in November 2008 to 1.25% in April 2009," he said. "The MPC has never lowered the interest rate below 1.25%, even when the Thai economy contracted 4.3% in the 2009 subprime crisis. If the MPC were to provide itself with a 2.5% interest space, it must hike the rate by 2.25% so as to not fall below 1.25%. But such a hike is incredibly difficult given the current economic situation."
Mr Amonthep said the MPC could also drop the interest floor below 1.25%, possibly 0.5%, but anywhere lower would be unlikely.
He said the MPC should provide explicit policies to prevent any financial market volatility, adding that raising rates should not have much of an impact on financial costs for businesses or households as they will be "slow, incremental and clear".
"It is clear that rate hikes are crucial in providing the MPC with the necessary policy space in the event of an economic crisis. But if a crisis breaks out before the MPC has given itself adequate policy space, it will have to resort to other methods to provide financial liquidity and reduce financial costs to stimulate investment and spending," said Mr Amonthep "It is expected that we will see an incremental rate hike in the first quarter of 2019."