Public Information Notice No. 05/150

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Thailand

October 27, 2005

On September 7, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Thailand.¹

Background

Thailand's economy continued to perform well in 2004 with strong growth and low inflation. In spite of high oil prices, recurring outbreaks of the avian flu, and the security situation in the south, real GDP increased by 6.1 percent. Headline inflation remained comparatively low at 2.7 percent and core inflation trended only slightly upward to 0.4 percent, well within the Bank of Thailand's (BOT) target range of 0-3.5 percent for core inflation. A confluence of factors—higher oil prices, slower partner growth, the downward electronic cycle, a devastating tsunami, a prolonged drought, and continued unrest in the south—led to a slowdown in activity and a marked deterioration of the current account at the beginning of 2005. However, the strong growth performance in the second quarter of the year suggests that the recovery may be already underway. Headline and core inflation rose in August to 5.6 and 2.3 percent, respectively, reflecting rising energy prices.

Monetary policy shifted to a tightening stance in 2004, amidst rising domestic oil prices, increasing capacity utilization, and a tightening labor market. The BOT has gradually raised its policy rate from 1.25 percent to 3.25 percent since August 2004, putting an end to a three-year long easing cycle.

In FY 2003/04, the central government recorded a small surplus of 0.3 percent of GDP, owing mostly to continued revenue overperformance due to a broader tax base and improved tax administration. In FY 2004/05, the central government balance is projected to be broadly balanced on account of continued strong corporate tax receipts, while allowing for a supplementary budget of B 50 billion (or ¾ percent of GDP). The overall public sector balance is projected to record a small deficit, ² reflecting higher capital spending by nonfinancial state enterprises and a lower balance for the extrabudgetary funds due to the Oil Fund. Thailand's authorities have also announced plans for B 1.7 trillion in infrastructure spending over 2005-09, part of which has already been included in the planned budget over the medium term. These "megaprojects" will bring public investment to about 9 percent of GDP, close to its historical levels, but well below its pre-crisis peak of 12 percent of GDP.

Thailand's external position remained strong in 2004, with the current account reaching a surplus of 4.5 percent of GDP and outstanding external debt falling to 31 percent of GDP down from 36 percent in 2003. However, the current account experienced a sharp reversal in the first half of 2005, reflecting high oil prices, the restocking of iron and steel products in anticipation of the megaprojects, softer partner import demand, the downward global electronic cycle, and lower tourist arrivals due to the tsunami. The current account deteriorated to a deficit of US$6.2 billion in the first half of the year—about 3.8 percent of GDP. The current account improved to a small surplus in July. The baht appreciated by around 3 percent (year-on-year) against the dollar in 2004, but depreciated slightly in effective terms. This trend continued until February 2005. However, between March-August, the baht weakened with the deterioration of the current account.

In the longer term, prospects for sustained growth depend on further action to address remaining structural weaknesses, especially in the corporate and banking sectors. While banks have strengthened their financial position significantly in recent years, nonperforming loans (NPLs) have yet to come down further. Corporates have also made advances in de-leveraging, but more work remains. The Thai Asset Management Corporation resolved 99 percent of total acquired assets in 2004 and improved transparency procedures, but a number of approved restructurings or foreclosures have yet to be completed.

Executive Board Assessment

The Executive Directors commended the authorities on their prudent macroeconomic policies, which supported Thailand's strong economic growth in 2004 and helped keep inflation comparatively low. Following this favorable performance, a confluence of domestic and external shocks—notably, higher oil prices, slower partner growth, a cyclical downturn in demand for electronic exports, a prolonged drought, a devastating tsunami, and continued unrest in the south—resulted in a sharp deterioration in the external current account and a marked slowdown in growth in the first quarter of 2005. Directors observed that the continued pursuit of disciplined monetary and fiscal policies, coupled with Thailand's flexible exchange rate regime, has however helped the economy weather these shocks and enabled stronger-than-expected growth in the second quarter of the year. Nevertheless, Directors considered that several risks still cloud the outlook.

Directors agreed that, at the current juncture, the main challenge for economic policy is to support growth while preserving macroeconomic stability. Although recognizing that the earlier slowdown was due in part to temporary factors, Directors pointed to continuing risks in the near-term outlook. In particular, they noted that a sharper-than-expected slowdown in partner country demand and additional increases in oil prices could delay the improvement in the current account, and the economic recovery could be slower than anticipated. If these circumstances were to materialize, Directors encouraged the authorities to allow the market-based exchange rate and the automatic fiscal stabilizers to lend support to the recovery. At the same time, they recognized that the substantial reduction in public and external debt achieved in recent years leaves Thailand in a strong position to confront adverse shocks. With regard to the medium term, Directors noted that growth will hinge upon continued advances in structural reforms and the proper handling of large planned infrastructure spending.

Directors supported the BOT's flexible management of the exchange rate and its commitment to continue to limit intervention to smoothing excessive volatility. Directors emphasized that exchange rate flexibility could play an important role in absorbing the current imbalances, and noted that the baht has been weakening with the deterioration of the external current account. In this context, several Directors observed that a further market-led adjustment of the currency may be needed if the recent external shocks to the economy prove to have a persistent impact on the current account.

Directors supported the BOT's early move toward tighter monetary conditions. Over the past year, amidst a closing output gap and rising oil prices, the BOT raised its policy rate in several steps. Directors supported the gradual approach pursued by the authorities in raising the policy rate. Most Directors also thought that the targeted use of prudential curbs by the BOT has been an appropriate response to prevent excessive exuberance in some sectors of the credit markets.

Directors agreed that the projected mild fiscal stimulus in FY 2004/05 is appropriate in view of the still-contained inflationary pressures and the uncertainties surrounding the growth outlook. They also considered the broadly neutral policy stance of the draft budget for FY 2005/06—inclusive of the planned infrastructure spending—to be appropriate, given the expected cyclical position of the economy. Directors welcomed the improvements in tax administration that have contributed to the recent gains in revenue collection.

Directors noted that a key medium-term challenge will be the effective implementation of the planned megaprojects. They emphasized that these projects should be prioritized and appropriately phased, and should not jeopardize fiscal and external sustainability. They were therefore encouraged by the authorities' commitment to carry out the megaprojects in a manner that will still allow for a reduction in the debt-to-GDP ratio and avoid excessive pressures on inflation and the external balance. Directors also recommended that the financing of the projects be transparent, that contingent liabilities be minimized, and that adequate monitoring mechanisms be put in place. Equally, Directors stressed the importance of containing the growth of current expenditure and sustaining the revenue effort in order to ensure medium-term fiscal sustainability.

Directors emphasized that sustainable medium-term growth hinges on the steadfast implementation of structural reforms. They observed that, despite substantial progress, NPLs of the banking system are still high. While welcoming the new measures implemented to expedite the resolution of such loans, Directors encouraged the speedy enactment of legislation to replace the full guarantee provided by the Financial Institutions Development Fund with a deposit insurance scheme and to allow state-owned Asset Management Corporations to buy assets from commercial banks. Directors supported the authorities' actions to deal with the largest state-owned bank and called for continued vigilance. With regard to Thailand's measures to discourage speculative flows, several Directors noted that such measures could be useful in the short term, but have drawbacks in the long term.

Directors considered it important to accelerate legal reforms in order to improve governance in the private and public sectors, and to further enhance the investment climate. They welcomed the measures implemented recently to improve accounting and governance standards. Directors noted that the ROSC on corporate governance will provide an opportunity to identify areas for further action. They also welcomed the authorities' decision to request an FSAP to be conducted in 2007. In addition, Directors encouraged faster progress with pending legislation in other economic areas to further enhance the investment climate.

Directors welcomed the authorities' strengthened commitment to privatization. They observed that the planned corporatization of Thailand's power company will be an important first step in this renewed effort, with the next phase involving the telecom sector. They underscored that steady progress on this front will boost investor confidence.

Directors commended the authorities for the progress achieved over the years with trade liberalization, which has served both Thailand and its trading partners well. Directors observed that recent bilateral free trade agreements (FTAs) being pursued by the authorities could help improve the domestic business climate and expand market access. They considered that bilateral and regional trade agreements are best framed as a complement to Thailand's broad-based trade liberalization, and encouraged the authorities to ensure that the FTAs are consistent with the broader goal of multilateral trade liberalization.