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As both Thailand’s Prime Minister (Yingluck Shinawatra, “elected in a landslide just four months ago” per the Economist) and economy continue to suffer (industrial production plunged 35.8% y/y and capacity utilization fell below 50% to 46.4% in October–the lowest respective prints on record as analysts ponder annual growth revisions), its markets spent the last week pricing in an expected 25-50bp rate cut from the Bank of Thailand’s (BoT) impending monetary policy decision–1w and 1m Bibor dropped 3bp and 7bp, respectively for instance, while the 14d repo rate at the last 14d BoT bilateral repo fell 3bp per observers. And while inflation continues to creep up ultimately the discord between headline and core should allow officials some leeway to not only maintain their hitherto credible inflation-fighting creed but also help preserve an enviable current account surplus (see chart) seen by officials as an effective inflation tempering tool but now under pressure from the plunging Bhat and dithering exports. To this end, despite some rate cut front running in the bond markets (2 and 5 year debt have narrowed by roughly 30bp during the past month) the yield curve has further room to steepen per Barclays, which cites in particular the 5y’s “ample systemic liquidity” in addition to lingering output contraction in 2012 which will likely persuade officials not to spare further easing if deemed necessary. That said, one shouldn’t discount the role that Thailand’s net reserve coverage will also play in helping policy makers accommodate.
Expectations of further front-loading of rate hikes—The Bank of Thailand began normalizing its monetary policy when it raised the benchmark interest rate by a quarter of a point to 2.25 percent on Jan. 12 following a similar increase in December, and many analysts now project a cumulative 75bp rise during the remainder of the year—have in turn flattened the front-end of the NDIRS (non-deliverable interest rate swap) curve. Moreover, because the floating legs for Thai rate swaps are derived from both interbank rates as well as forward dollar/baht market rates, front-end rates have been under added pressure (in a rising rate environment) as the central bank’s recent round of three and six-month currency forward purchases (to sterilize spot buying of dollars, more evidence that in fact EM bond flows are stickier than equities regardless of inflation) has drastically narrowed the gap between the 6m fixing rate and policy rates. In sum, spreads between 1-2 and 2-5 year swaps have tightened considerably this month while domestic bond yields have also increased in kind, reflecting what analysts term “rising but manageable” inflation pressures given that food and energy prices may be contained going forward by favorable (cooler and wetter than normal) weather patterns and the government’s use of an oil levy fund, respectively. Interestingly, the aforementioned rise of short-end swaps may already be “overdone”, per Lum Choong Kuan, head of fixed income research at CIMB Investment Bank, especially if the market has overshot on its rate normalcy projection. That said, movement in the 6m fixing rate may not be done, and as such swap spreads have room to tighten further. Rahul Bajoria, an analyst with Barclays, mentions for example that “the rise in the fixing rate may continue in the coming weeks as Thai asset managers, who invested heavily in FX-hedged, short-term Korean bonds, are likely to repatriate those investments, given that the attractiveness of Korean money market investments has declined significantly.”
Macro Man’s observation relating to the lack of consistency between spot prices and the spread between the front and 5th futures contracts (and the resulting implication that “much of what [is going on in] food inflation and non-core CPI [in emerging markets] is going to be far from a passing problem like [it was] in 2007-2008”) is likely to give fits to EM central banks such as the Bank of Thailand, which last week raised its benchmark interest rate for the fourth time in seven months and signaled it will boost borrowing costs further to contain inflation. Taken in tandem with rising raw material prices, which ultimately wreak havoc on margins, the largest minimum wage increase since 1993, higher pay for civil servants and continued robust domestic demand, a somewhat secular rise in food prices should contribute to at least one more BOT rate hike in the coming months and also lend support to further currency appreciation even at the expense of slowing export momentum. Barclays, for instance, expects USD/THB to “head down to 29.0 in 12 months.” Yet rising rates and inflation–a thorn for equity markets as a whole–may be a blessing for some firms. As Chaiyaporn Nompitakcharoen, an investment strategist with Bualuang Securities told Bloomberg, “banks and commodity shares are good inflation plays for investors. Net interest margins are widening as most lenders raised loan rates at a faster pace than deposit rates.” Moreover, he said, Thai Vegetable Oil, the country’s biggest soybean supplier, and Charoen Pokphand Foods, the largest producer of animal feeds and meat, will have higher earnings on increased commodity prices.
Keep an eye on the Lao Security Exchange, which per reports hopes to raise $8bn in stock and bond sales in order to generate investment into the country over the next five years. The market opened last week and lists only two companies (Electricite du Laos Generation or EDL, a unit of the state-owned power producer which overseas investors are limited to a cumulative 10 percent stake, and Banque Pour Le Commerce Exterieur Lao or BCEL, the state controlled lender whose shares are verboten to foreigners), but as Templeton’s Mark Mobius noted, the admittedly woefully underdeveloped communist country and subsistence-farming oriented economy still offers “valuable opportunities” in industries from construction to banking as it increases its infrastructure investments. For one thing, future consumption will be underpinned by the purchasing power parity (PPP) rise of a population of roughly 7 million people, 40 percent of whom are under 15 years old and currently earn only $2.6 per day on average (as an example of how explosive this kind of low-base growth can be, consider Vietnam, where GDP based on PPP/per capita trebled since 1995 after rising roughly 5x since 1980). For another, the country has several heavy and hungry hitters with skin in the game–Beijing is covering 70 percent of the project investment for a high-speed railway link (to this end, watch if and when domestic Lao cement producers ever list shares or raise debt, since domestic cement is cheaper to produce but will be dear for years to come), for instance, while also building up resort, hotel and casinos along border areas for its growing base of tourists and also joint venturing in order to secure access to raw materials such as iron ore. Thailand, another source of tourism, will also purchase 95 percent of the electricty generated by the country’s initial $1.3bn hydroelectric and World Bank supported-dam, one of many dams which could ultimately allow Laos to become “Asia’s battery”. To this extent, “Laos is fast establishing itself as one of the principal territories in the South-East Asian region for large scale and innovative hydropower project financings,” according to Allen & Overy’s Ben Thompson. Finally, watch for a potential secular rise in mineral/metal prices (copper, gold and silver specifically) and its related dealmaking to support Laos’ future economic development.
The plight and root cause of surging physical rubber prices in Thailand (the world’s largest producer with 31% of global natural rubber output), Malaysia and Indonesia, as well as rubber futures across various exchanges, somewhat echo that of the cocoa industry in the Ivory Coast: persistent underinvestment in the past and thus a continual dependence on aging infrastructure (i.e., rubber-yielding trees planted in the 1980s and thus just beginning to enter the stage of declining yields, per Macquarie, an investment bank) and a stable-to-shrinking supply of agricultural land–is finally translating into increased volatility in quality and yield. Coupled with ever-changing weather patterns and voracious demand from emerging markets for tires, condoms and gloves–led by China, whose tire consumption according to the FT grew 57% y-o-y for 1H2010 per Pirelli–and prices are likely to stay trending upward. The cash price in Thailand gained 1.6 percent to 130 baht ($4.40) per kilogram this week, just shy of the record 130.55 baht on April 27th. Yet “prices may surge above 150 baht by the end of this year as demand remains robust while supply is limited,” said Supachai Phosu, the country’s deputy minister of agriculture and cooperatives. Chinese demand, by the way, is likely to increase its upward rate of acceleration, if for other reason than the continuation of a government subsidy for fuel-efficient cars and also the enduring prospect of further surprise rate hikes underpinning current consumption.
The Bank of Thailand’s decision to keep its key, one-day bond repurchase rate (1.75%) unchanged–effectively an attempt to ease the rampant baht appreciation (it recently hit a 13-year high versus the dollar)/pressure on exports discussed here earlier–followed its decision last week, per Bloomberg, to “[scrap] a tax exemption for foreign investors in domestic bonds to slow capital inflows that have pushed up emerging-market currencies.” Yet according to Santitarn Sathirathai, a Singapore-based economist at Credit Suisse Group AG, “it’s only an exception to the trend of hiking rates.” Indeed, late last month the state’s finance ministry opined that the rate “may climb to 2 percent by the end of the year and 3 percent next year.” Yet as long as core (1.1% y-o-y) consumer price inflation remains removed from the high-end of the Bank’s target range of as much as 3%, and state price-influence remains in tact (per Businessweek, in June “the government extended state subsidies on mass transportation and energy costs for six months, while the commerce ministry controled prices of key consumer products to help reduce the public’s burden following political clashes in the second quarter that killed at least 89 people”), it’s conceivable that rates stay stagnant. That said, as The Economist pointed out two weeks ago while citing a fascinating study authored by two economists at Goldman Sachs which looked at the pace at which central banks in emerging Asian economies built up reserves by buying foreign currency (and then scaled the absolute amounts in question by the country’s base money supply in order to determine a net effect), Thailand–along with Malaysia–have had the most “appreciation-friendly” regimes in Asia since 2006 (to boot, China’s intervention in relation to the size of its economy has been relatively small, the piece shows). With all of this in mind, is a carry trade into baht-tied assets still viable, absence of the 15 percent tax exemption be damned? Given the impending round of quantitative easing in at least one developed country, the emerging/frontier market flow may still have a ways to go. “The Fed’s quantitative-easing speculation is back in focus and that means growing optimism of more inflows into Asia,” Hideki Hayashi, a global economist at Mizuho Securities Co. in Tokyo, told reporters today.
Regardless of your short-term view on rates, one way to currently play Thailand may still be through its bustling financial services sector. During the first half of this year, for instance, the country’s banking sector realized 61b baht in net profits–a 42% increase y-o-y–on the back of strong net interest margins (NIM, i.e., the difference between interest income and interest expense expressed as a percentage of interest-bearing assets) and a continually declining non-performing loan– NPL–ratio (a proxy on underlying asset quality). These results continued into the most recent earnings period, as analysts’ “outlook for Thai banks remains bright as strong loan growth should continue in the fourth quarter and into the start of next year after healthy economic growth.” And while in theory rising rates may be NIM-negative (for liability-dominated balance sheets, a rising interest rate environment–and thus a flattening yield curve–suggest a given bank’s net interest margins will be comprimised given the cost of deposits outpacing asset yields), Suphachai Sophastienphong, chief economist at Siam City Bank, pointed out in August that in reality this is probably not the case:
“Empirical evidence in Thailand appears to contradict the prevailing orthodoxy that changes in interest rates and the slope of the yield curve (changes in the levels of long-term and short-term rates) will have significant impact on banks’ net interest margins. Over the past half a decade net interest margins have been hovering around 3 percentage points, reflecting, in the view of many pundits, less-than-competitive pricing behaviour and inefficient intermediation–irrespective of the shape of the yield curve . . . Even in parts of the developed world, the correlation between bank profitability and the yield curve has weakened considerably over the past few decades thanks to deregulation, securitisation and the use of interest rate swap as well as other derivatives contracts.”
In order and by assets, Thailand’s biggest banks are Bangkok Bank, Krung Thai Bank, Kasikornbank and Siam Commercial Bank (the country’s oldest).
The baht’s credit-crunch derived decline looks but a blip (see chart, right) as the currency’s long term uptrend, which dates back to the latter half of 2005, remains not only in tact, but even more steadfast as the central bank predicted earlier this month that the economy would grow in 2010 (its 2Q10 yoy growth stood at 9.1%) at the fastest pace since 1995. And per The Economist last week, the IMF predicts full-year growth of 7%, ahead of Malaysia, Indonesia and the Philippines. Undeterred by the potential for trade competitiveness erosion (exports rose for a 10th straight month in August versus last year, buoyed by a healthy demand for auto parts and electronics), Thai Finance Minister Korn Chatikavanij told reporters on Wednesday that the baht’s gains were “unavoidable” because of the strong economy and that the currency was “likely to rise further” against the dollar. That said, not everyone is so sanguine: local traders opine that prices of rice, for instance, can be expected to rise further; the benchmark 100 percent B grade Thai white rice was steady at $490 per ton earlier this week “but could rise over the next few weeks given a stronger baht,” per reports. Moreover, worried about inflation the central bank last month raised interest rates for a second consecutive month, to 1.75 percent. And Thanawat Polwichai, director of the Economic and Business Forecasting Centre at the University of the Thai Chamber of Commerce, called on the central bank at the beginning of the month to help defend the currency’s seemingly unabated rise. “The BoT should tell the public of its policy to curb the baht’s value to suit the current economy,” Mr Thanwat said, adding to reporters that “if the Thai currency strengthens to less than 30 baht to the USD in the fourth quarter of the year, Thailand would face damage of about 100 billion baht in revenue lost in the export and tourism sectors, in turn shrinking GDP growth by roughly one percentage point.”
At 30.67 per dollar, just below its 13-month high, the baht has risen 8.8% this year, making it the third-best Asian performer after the Malaysian ringgit and the Japanese yen. In fact, Chatikavanij mused, the government’s plan to “fast-track infrastructure spending” would be aided by a stronger baht, since the cost of imports would be lessened. The strong currency and humming economy stands in stark contrast to ever-simmering political unrest which periodically boils over into full fledged street violence. Yet The Economist notes that “tourists have returned in search of beaches and bargains [and] investment continues to trickle in.”
Analysts expect inflation in Asia to slow further this year, with some countries likely to see deflation, as domestic consumption and oil prices ease, and as demand remains low in much of the developed world (the main export markets for Asian companies), pushing down prices.
Inflation in Thailand, Indonesia and Taiwan fell more than expected in December, causing observers to predict another round of interest rate cuts as governments in the region try to prop up struggling economies. Inflation tumbled in Thailand to a six-year low of 0.4% and fell in Indonesia to a six-month low of 11%. In Taiwan, it hit 1.2%, the lowest level in more than a year. “We will see aggressive rate cuts by the Bank of Thailand this year,” said Usara Wilaipich, an economist at Standard Chartered Bank. “We also will see more downside risk to inflation and probably a negative inflation rate in March to June, or temporary deflation, which should allow the Bank of Thailand to make a bigger rate cut.”
Both Thai and Indonesian central banks lowered their benchmark rates in December for the first time since September. Thailand cut its main interest rate by a full point, to 2.75%, and Indonesia lowered its rate by 0.25 to 9.25%. Many investors expect an imminent rate cut in Indonesia, the largest economy in southeast Asia, which has been experiencing higher inflation than most of its neighbors. But officials expect that to slow sharply this year. “Inflation can ease to a single digit in March,” said Rusman Heriawan, the head of Indonesia’s statistics agency, adding that there was scope for additional cuts in subsidized fuel prices.
JGW
Frontier Markets 