The world began 2012 on a bad note, and looking ahead the outlook remains weak. The tension in the developed countries when it comes to solving sovereign debt problems in Europe means that the after-effects of the 2008-09 crisis have not yet played out fully.
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In Thailand, the country's economy is expected to rebound strongly in 2012, after severe floods took a toll on growth in the fourth quarter 2011. This is mainly attributed to easing supply disruptions and pent-up domestic demand. While the near-term outlook is positive, the country faces several medium- and long-term challenges, many of which will take years to resolve. Collective responses from all stakeholders to strengthen economic resilience and long-term competitiveness are necessary to ensure sustainable economic growth amid global and domestic uncertainties.
Key challenges
With increasing global integration in goods, services and finance, it is becoming harder to shield domestic economies from developments overseas. Globally, the risk of economic slowdown has intensified, particularly with the continuing European debt crisis. As a small open economy, Thailand is exposed to the global markets, with little buffer.
Although the potential impact of this on Thailand's financial institutions appears limited due to small direct exposure, the impact through trade and financial markets is more significant. In terms of international trade, Thailand relies heavily on exports, which account for as much as 65% of the country's gross domestic product (GDP). With a large proportion of demand for Thai exports coming from the G3 economies – the US, Europe and Japan – and economic slowdown in Thailand’s major trading partners becoming more noticeable, the negative impact on exports are already being felt. Exports of electrical appliances, agriculture and intermediate products, in particular, have experienced a sharp decline.
Over the longer term, therefore, a shift in macroeconomic policy to rebalance the source of growth between external and domestic demand is needed. As more balanced growth would help enhance economic resilience by lessening the country’s exposure to the global economy, the Thai government has been looking to gear its policies towards domestic consumption and infrastructure investment.
In terms of financial activity, Thailand is also increasingly exposed to more volatile capital flows and exchange rate fluctuation. As central banks in developed economies have largely adopted unconventional monetary measures and flooded the global financial market with ample liquidity, large and volatile capital inflows have become more common in Asia, including Thailand. This in turn raises key policy issues on capital flows and exchange rate management.
Asia's growing role
The rise of Asia and increasing regional integration is another challenging factor facing Thailand. Despite continuing problems in the eurozone and other major advanced economies, domestic demand in many Asian economies remains relatively robust and will, therefore, be an important contributor to global growth. Therefore, the expanding role of Asia and the Association of South-east Asian Nations (Asean's) commitment towards economic integration, under Asean+3 (including China, Japan and South Korea), Asean+6 (adding Australia, India and New Zealand) and the Asean Economic Community (AEC) in particular, would make Asean a more interesting place to do business.
A more integrated Asian economy would provide vast economic opportunities for Thailand, including enlarging market size, minimising transaction costs, enhancing efficiency and productivity. However, liberalisation would also entail more intense competition, and thus taking full advantage of opportunities from integration will require Thai businesses to focus on those particular areas where Thailand has an advantage. Necessary reforms to enhance competitiveness include promoting our core competent sectors, improving our quality of human capital as well as upgrading our basic infrastructure.
More liberalisation would also facilitate a freer flow of capital within the region, which will in turn promote capital market development in terms of increased market liquidity, and provide greater access to financial services at lower cost. Nevertheless, capital liberalisation has to be undertaken gradually with adequate financial infrastructure to safeguard against macroeconomic instability and to put capital flows to the most productive use possible.
Domestic pressures
Internally, labour shortage and increasing domestic cost of production in Thailand have raised much concern that these problems could weaken the country’s long-term competitiveness. For more than 20 years, Thailand has been stuck in a middle-income trap. And for a long time, Thailand has relied on cheap wages to compete in labour-intensive products. But as incomes rise, so do production costs and wages. This has undermined the old competitiveness of labour-intensive, low-technology manufacturing production.
Although Thailand has tried to move up the value chain into exports of more technologically advanced products, such as electronics and automobiles, this has not enabled the country to escape the middle-income trap. Thai companies still just assemble products designed by other countries, instead of investing in research and development to innovate their own products. Rising labour costs, as a result of the government’s minimum wage hike policy adopted earlier this year, could provide a good opportunity for Thailand to move up the global value chain. It is hoped that businesses will adjust to produce higher value-added products and Thai workers will pursue higher value work with more productivity to receive higher pay.
Lastly, strengthening sophisticated and flexible supply chains is needed to attract foreign direct investment when the benefit of low-cost labour no longer applies to Thailand.
Government action
For the government's part, public investment in infrastructure and medium-term fiscal sustainability are important challenges. In times of economic downturn, fiscal stimulus is crucial to sustain growth, as evidenced by Thailand's robust economic recovery from the worst floods the country has experienced in 50 years. Amid current global economic uncertainty, fiscal stimulus is needed to alleviate the impact of slower global demand. Thailand is lucky to still have fiscal space to accommodate additional spending, and so appropriate and productive use of future government spending is important.
As the example of the eurozone shows, excessive spending can cause unsustainable public debt in the long run, with negative consequence for sovereign ratings and a country’s cost of borrowing. In the face of intensifying global competition, it is important that Thailand makes a transition from resource-driven growth using low-cost labour and capital to productivity-driven growth, by focusing more on investment in infrastructure and education. So far, investment on infrastructure in Thailand remains quite low when compared to the international standard, and more needs to be done. As the latest Global Competitiveness Report by the World Economic Forum shows, Thailand’s competitiveness ranked 39th out of 142 countries surveyed, dropping one place from the previous year. Of particular concerns are education and infrastructure, where Thailand ranked poorly.
Collective responses
All of the challenges that lie ahead highlight the importance of the need to rebalance Thailand towards a more domestic, demand-driven economy as well as a more knowledge and productivity-based society. The key strategy for this paradigm shift requires a common vision and strong commitment among all stakeholders.
The Bank of Thailand's (BOT’s) role in meeting these challenges is first and foremost to ensure macroeconomic and financial stability. A stable macroeconomic environment will not only foster business-friendly climate, but also provide a key prerequisite for long-term sustainable growth. In this regard, over the past 12 years and through several crises, the BOT has conducted monetary policy under the flexible inflation-targeting framework, whose regime has kept Thailand’s inflation low, helped strengthen the central bank’s commitment to price stability, while also ensuring a strong and stable financial system.
The second role is to promote Thailand’s competitiveness and adaptabilities. In light of this, the BOT’s policies are aimed at facilitating business adjustment in the face of increasing competition. For example, BOT’s Capital Account Liberalisation Master Plan will allow greater flexibility in cross-border investments and promote more balanced capital flows.
Another important role of the BOT is to enhance efficiency in financial intermediaries by implementing the Financial Sector Master plan, where improvements are hoped to be achieved in three areas, namely expansion of available financial instruments and innovation, increased financial access, and reduced cost of financial services.
As for the government, together with preserving fiscal discipline for sustainable economic growth, it should focus on public infrastructure investment, including social infrastructure, particularly the education system, and physical infrastructure. Well-developed infrastructure enhances growth through three main important channels: public capital stock formation, 'crowding in' effects on private investment, and productivity improvement.
At the same time, the private sector, as the ultimate driver of economic growth, should aim to move up the value chain by relying more on machinery, research and development and improved labour productivity. These will result in higher value-added products, making Thai companies compete better in an increasingly competitive global market. Diversification of products and markets are also needed to alleviate the impacts of heightened global uncertainties.
Despite a rapid recovery from the worst floods in half a century, Thailand still faces considerable challenges, ranging from global financial fragilities, rising competition from regional integration, an increasing labour shortage and the domestic cost of production, as well as medium-term fiscal sustainability. These challenges, however, come with great opportunities for all stakeholders to work together towards lifting Thailand’s long-term economic growth potential and upgrading the country’s position in this increasingly complex and uncertain globalised world.
Prasarn Trairatvorakul is the governor of the Bank of Thailand.
