CABLE: Recent Thai economic policy – why?

“93736”,”1/24/2007 9:18″,”07BANGKOK499″,

DE RUEHBK #0499/01 0240918
P 240918Z JAN 07




E.O. 12958: N/A


C. 06 BANGKOK 7650
D. 06 BANGKOK 7504
E. 06 BANGKOK 7484
F. 06 BANGKOK 7435

BANGKOK 00000499 001.2 OF 005

1. (SBU) Summary. Investor confidence in Thailand has
suffered a series of shocks over the past 40 days. The
introduction of more stringent capital controls effectively
limiting new investment, a series of bombs in Bangkok on New
Year’s Eve, and proposed amendments to the Foreign Business
Act (FBA), all have combined to shake both foreign and
domestic confidence in the economic management capability of
the current government. This has been exacerbated by the
regime’s failure to consult with stakeholders, rapid
policy-shifts and apparent lack of concern about the
short-term impact of their decisions. Despite this, most
economists continue to forecast Thailand’s GDP for 2007 to
come in at about the same rate of growth as was achieved in
2006; 4-5 percent. Despite the benefits of a decline in oil
prices and continued strength in Thailand’s export markets,
the perception that the current government is economically
and politically inept will likley cause Thailand’s economy to
underperform, especially in comparison to its regional
competitors. End Summary.

2. (U) On January 17 the Monetary Policy Committee (MPC) of
the Bank of Thailand (BoT) announced a 19 basis point
reduction in the central bank’s interest policy rate to 4.75
percent (the 1-day repurchase agreement rate which replaced
the previous policy benchmark based on the 14 day repo). The
reason given by the MPC for their action was “Latest economic
indicators point towards a slowdown in domestic demand. In
particular, consumption and investment…showed a continued
moderation. On the other hand inflationary pressures are
expected to moderate…”

3. (SBU) As we have reported (reftels), economists have been
predicting for over a year that domestic demand and private
investment would grow only modestly in 2006, and they were
proven correct with these indicators growing at about 3
percent and 2.9 percent respectively. The only driver to the
economy was the export sector which grew about 16 percent in
US$ terms. With the 14 percent appreciation in the baht last
year, however, the effective contribution of exports to
economic growth was much less but still was sufficient to
achieve a 4.6 percent increase in GDP for the year.

Confidence Lagging

4. (SBU) The reasons for the poor consumer and investor
confidence in 2006 were a combination of the political
turmoil in the run-up to the September coup, concerns about
an economic slowdown in Thailand’s major export markets, and
the high price of oil in an economy that imports all its
crude oil and is highly energy inefficient. The coup
initially provided a lift to sentiment since it was seen as
resolving the political unrest and providing a clear path to
new elections along with a technocratic government that would
formulate economic policy untainted by political and
corruption-related factors.

5. (SBU) In fact, the economic mood in Thailand is now quite
negative. Offsetting the good news of the recent moderation
of oil prices has been a series of policy decisions, along
with the New Year’s Eve bombings, that are widely seen to
have been either badly managed, politically motivated, or
both. The military-installed government is under growing
criticism for not yet bringing any corruption charges against
former PM Thaksin, for heavy-handed efforts to intimidate the
media, and a general air of ineptitude.

Capital Controls – Why so “Draconian”?

BANGKOK 00000499 002.2 OF 005

6. (SBU) There is little doubt that Thai exporters’ margins
were under severe pressure from the appreciating baht before
new capital controls were implemented on December 19. Even
those who supported the measures at the time now seem to be
having second thoughts about the magnitude of the BoT
response to the problem, terming the measures “draconian” and
“using a sledge hammer to kill a fly”. Financial market
participants with whom we have spoken, including Stock
Exchange of Thailand management, bemoan the “clear lack of
understanding of how markets work” within the BoT and the
failure to consult with market participants beforehand. An
SET senior official told us “we are officials charged with
running the stock market, yet they (BoT) never bothered to
ask us what might happen when they put in their measures
because they don’t trust us. Actually, they don’t trust
markets.” Similar criticisms were directed at Deputy PM (and
former BoT Governor) Pridiyathorn. The CEO of a major stock
broker said “what sort of policy do you expect from a
regulator”? Pridiyathorn did not help his case when he
announced that the market’s steep decline in the wake of the
capital controls announcement was “illogical.”

7. (SBU) Senior officials at the BoT continue to insist that
they had no choice but to act as they did; arguing that they
could not segregate capital flows and so had to apply the
reserve requirement to all incoming capital (a policy quickly
reversed for equities and that has been slowly and quietly
liberalized on a continuing basis. Many believe that the
controls will be mostly lifted within another month). Deputy
Governor Atchana, when asked why the BoT did not try and use
interest rate reductions as a first step to reduce baht
appreciation replied that the Bank was concerned about the
Ministry of Commerce lifting price controls on about 100
controlled items and what such an action might do to
inflation. She also argued that more severe action was needed
to drive out the speculators considered to be the cause of
the rapid baht appreciation and cutting rates “was just what
the speculators want us to do. Why should we reward them.”
Several observers told us that Pridiyathorn’s philosophy is
that speculators only respond to “severe punishment” and that
over time, markets always revert to their underlying value
regardless of short-term shocks.

8. (U) The SET was the worst performing stock market in Asia
in 2006, down about 4.8 percent for the year. Even before the
capital controls were put in place, the market still
underperformed its regional competitors, up only 3.5 percent
through the end of November on the back of foreign investors
buying over net US$2 billion (Thais were net sellers
throughout the year). Over the past month, the SET has
declined 9 percent while Asia ex Japan has appreciated 3
percent. In spite of recent polices, foreigners have sold
only a net US$700 million of their Thai equity holdings.
Reasons given for this are 1) long-term funds are content to
maintain their exposure to Thailand to be in line with the
MSCI global index benchmark, 2) with limited liquidity in the
market, funds were concerned about moving the market further
if they attempted to sell too quickly and 3),hedge funds have
come back into the market over the past week expecting a
bounce-back because the market is seen as being unusually
cheap. As an indication of the lack of trading volume,
year-to-date foreigners were net buyers of US$206.3 million
in equities and contributed 42.1 percent of total market

No Keeping the Baht Down

9. (SBU) Some local observers believe that the BoT analysis
of the causes of the baht’s appreciation was both overly
simplistic in blaming the problem on “speculators” and not
simplistic enough given the increasing current account
surpluses in the last half of the year. Some note that,
despite BoT rules requiring exporters to remit all their
export earnings and convert them to baht within 14 days of
payment, many kept US$ accounts overseas funded (contrary to
BoT regulations requiring all export earnings to be remitted

BANGKOK 00000499 003.2 OF 005

and converted into baht within 14 days) by a portion of their
earnings. With the accelerating decline of the dollar, there
was a rush in the last quarter of 2006 for Thais to stem the
depreciation of these holdings and convert to baht. Several
bankers have told us that their exporter clients had an
insatiable demand for baht every time the US$ had even a
small rebound and that this accelerated the baht’s rise.

10. (SBU) Further exacerbating the baht’s strength was the
practice of some multinationals (especially Japanese) to
undercapitalize their Thai operations and then fund them
through intra-company loans. By doing so, the local operation
would remit interest payments to the parent with only a 15
percent withholding tax and no problems from the BoT for the
remittance (as opposed to occasional problems receiving BoT
approval for remitting surplus capital). This practice also
reduces the Thai operation’s profitability, and therefore the
amount due the Thai taxman under the 30 percent corporate tax
rate. Many of these companies also participated in the
Japanese carry trade; borrowing at about 30 basis points in
Japan to fund their Thai operation, plus some extra to invest
in RTG short-term debt to earn 5 percent which would then be
sent back to the parent as part of their debt repayment. This
prompted the BoT to include intra-company loans under their
new reserve regulations with the effect that now many local
operations of multinationals must either prove to the BoT
that the loans really are for operating purposes (a
cumbersome process) or borrow from local banks at
considerably higher interest rates.

11. (SBU) In any case, the result has been the baht
stabilizing at around 36/1USD but has caused the cost of
capital to increase by about 30 basis points and liquidity on
the capital markets to decrease. Bankers here tell us that a
significant amount of baht trading now takes place in
Singapore and that there is a wide spread (about 1 baht)
between offshore and onshore baht/US$ exchange rates. Bank
liquidity, while more than adequate for the larger banks,
will be impinged by the application of International
Accounting Standard 39 by the BoT. This rule requires Thai
banks to set aside more collateral for non-performing loans,
a rule that some of the less-well capitalized Thai banks will
have to stretch to comply with. All this has acted as a
further brake on Thai business’ impetus to invest more in
their operations. Exacerbating that reluctance has been the
proposed amendments to the Foreign Business Act.

Foreign Business Act – So Many Questions…

12. (SBU) As has been reported (reftels), there remains
considerable uncertainty about the final form of the proposed
FBA amendments and how they will be implemented. We have been
told by several sources that the amendments as drafted by the
Ministry of Commerce would have opened several service
sectors to unlimited foreign ownership but that, after
considerable cabinet debate, the amendments focused on
extending the definition of an alien corporation to include
as a measure voting rights (as well as share ownership)
controlled by non-Thais, to increasing penalties for
non-compliance, and to offer the possibility of receiving a
license to continue operating and shareholder structures for
some existing businesses that in future will not be

13. (SBU) At a time when private investment is moribund and
FDI is down by more than half from 2005, less than one month
after investor sentiment was why wounded by the promulgation
of the capital control regulations and only weeks after the
New Year’s Eve bombings, why would the RTG choose this time
to propose new laws restricting new foreign investment and
threatening some existing investors with the retroactive
aspects of the proposed amendments? If we take at face value
the RTG’s claim that they are simply “closing loopholes to
the existing law”, the questions arise of why they 1) didn’t
first charge and try companies with violating the FBA under
existing law and 2) why they didn’t consult with the foreign

BANGKOK 00000499 004.2 OF 005

business community before making the changes?

14. (SBU) It is privately acknowledged by the Deputy PM and
widely understood in Thai society that the real reason for
the amendments is that there is a political imperative to
find the Shin Corp-Temasek transaction illegal. Despite the
fact that former PM Thaksin has already received US$1.9
billion for the shares he and his family sold in the
transaction (now mostly residing in accounts at Siam
Commercial Bank and Krung Thai Bank where they are closely
monitored to ensure no funds are transferred abroad) and
there are no Thai laws that make the seller of an asset
responsible for ensuring the buyer complies with FBA
regulations, the current government is anxious to show that
this transaction was illegal in order to “prove” the corrupt
nature of the former PM but are apparently unable to do so
under the present FBA. However, if this is the only reason to
amend the FBA, the government could have amended the National
Telecommunications Act, the law which governs all aspects of
that sector including limits on foreign equity participation,
rather than the more general FBA.

…And So Many Answers

15. (SBU) The answer to this question as provided by DPM
Pridyathorn was that, because the current FBA (and Telecom
Act) lack an effective definition of the term “nominee”, and
it was through the use of nominees holding shares on behalf
of Temasek that the Singapore company worked around the 49
percent limit on foreign ownership of Thai telecom companies,
it would be up to a court to provide a definition of the
term. Rather than “the nightmare” of leaving such a
definition to the court and then having it apply to all
nominee structures in Thailand, Pridiyathorn argues that his
government has taken the initiative to better define legal
and illegal structures and to offer a way forward for most
existing companies that might fall afoul of the amendments.
He has said that by providing a better law, foreigners in the
future will know what they can or can not do in Thailand and,
as a result, Thailand will attract more FDI. Unfortunately,
the fact that the term “nominee” remains undefined means
there remains considerable scope for imaginative lawyers to
find ways around the new restrictions. It also means that
companies will not necessarily know if they are violating the
new law or not. We believe that one reason “nominee” is left
ill-defined is because many Thai companies and families get
around non-FBA restrictions on ownership (especially laws
limiting a person to 5 percent shareholding in a commercial
bank or cross-holdings between banks and non-financial
companies) through the use of nominees.

16. (SBU) As is often the case in Thailand, there are various
stories to explain that which is difficult to understand. We
have been told, for instance, that a major Thai conglomerate
with interests in telecom and retail has sought the FBA
restrictions as a way to further their current market
position and limit future competition. The quid pro quo will
be that the group will help finance a marketing campaign for
a positive vote on the referendum required for approval of
the constitution currently being drafted. This is a response
to the RTG concern that Thaksin will use his funds to finance
a “no” vote campaign against the new constitution.

17. (SBU) While there may be some truth to the story, we find
it more likely that the recent moves of the interim
government directed at foreign interests are primarily moves
by the traditional Thai elite reasserting control over the
Thai economy. Following the Asian financial crisis and
Thaksin’s policies that had the potential to significantly
liberalize the services sector, these recent laws and
regulations are a reaction to the perceived further potential
loss of Thai-elite control over critical aspects of the Thai
economy. It probably is a safe bet that the current
government would never have negotiated the 1994 GATS
agreement, with its phased liberalization of the retailing
and telecoms sectors, and is looking for a way to duck its

BANGKOK 00000499 005.2 OF 005

GATS commitments or at least minimize their practical impact.
The moves are also part of the general roll-back of all
things Thaksin-related. In the minds of the elite, these
actions are not considered anti-foreign. They are considered
as protection against the vagaries of foreign capital and the
assurance that such critical sectors as telecom, banking and
transport remain under Thai control and, therefore, are
managed for the long-run good of Thailand (as opposed to the
“short-term interests of foreigners who tend to focus on
quarter-quarter financial results”). There may have been a
desire to liberalize less critical sectors; architectural
services, advertising or restaurants, for example. But the
political capital needed to liberalize some and not other
sectors would cost more than the government was willing to

What Next?

18. (SBU) Most foreign businesses that are here will stay
here despite the increased policy uncertainty. Many note that
the BoT has already considerably softened its capital control
rules and expect that there will simply be a new series of
loopholes when the FBA is promulgated. New investment will
also continue for sectors in which Thailand is most
competitive, especially automotive and tourism. But in other
sectors where Thailand is growing increasingly uncompetitive
or if there is less reliance on existing investment, new
investment is increasingly going to go elsewhere. An example
of this thinking is a US technology company with factories in
Thailand, Malaysia and Taiwan in addition to the US. A new
plant was destined for Thailand but, following the coup and
then the capital controls, the decision was made to put the
investment into Malaysia. As the regional manager told us,
“even though the capital controls and FBA won’t affect us,
why should we put additional money into Thailand when we
can’t see what the political system is going to be a year
down the road and the current government seems uninterested
in what the foreign community thinks.”

19. (SBU) Most economists here predict 4-5 percent GDP growth
for 2007. When asked to explain how that can be when domestic
consumption, private investment and exports are all forecast
to grow at a lower rate than in 2006 when 4.6 percent growth
was achieved, they point to anticipated increase in
government spending. Given the fact that increased
disbursements are unlikely until Q3 this year, the impact of
government spending on GDP growth for the year as a whole
will be marginal. The confidence in continued 4-5 percent
economic growth is based on faith that this is the nation’s
“natural” rate of expansion. And no matter how poor
government policy may be, as long as private companies have
the financial flexibility to operate and the exchange rate
remains competitive to that of Thailand’s competitors, the
country will grow at its “natural” rate, regardless of what
most long-term foreign investors do. We agree that the Thai
economy has underlying strengths that probably will prevent
2007 GDP growth from falling much below 3 percent. If the
stock market is a forecaster of future economic events, it is
projecting a weak performance for Thailand this year.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s