Towards the end of last year, we began to see equity funds flowing out. The stock market has also taken a downturn and the baht has weakened. This is quite the opposite picture from the whole of 2010 and is true also for Indonesia. One naturally wonders if this is the beginning of a "reversal" but first, let's take a look at the "why".
What is happening in the US? The stock market has been on a rally. The US dollar index has been rising from its trough in mid-October and is now trading sideways. Gold - a substitute asset class for the US dollar - has also been range-bound after rising steadily since mid-2010.
The economic fundamentals supporting this picture rest on the fact that retail sales, industrial production, corporate earnings and even employment have all improved. Evidently, analysts are hopeful that the US economic recovery is on firm footing and have been revising 2011 growth estimates up, with the latest Bloomberg survey as of January at 3.1 per cent, from 2.6 per cent in December. The facts are enough to change investors' course of action, but are they enough to sustain the recovery?
Most economists, including the Fed chairman, agree that a double-dip recession is unlikely. But admittedly, the recovery has neither been strong nor broad-based enough and the Fed is likely to continue with QE2 as scheduled. Further tax cuts will have medium-term fiscal implications. And across the time zones, despite continued growth in core EU economies, progress on resolving the sovereign debt crisis in the peripherals is still lagging behind and CDS spreads of PIIGS continue to remain high.
Overall, things look brighter but concerns over the US recovery and global fiscal mess are not over.
The implications of these recent developments for Thailand's financial stability are as follows. First, the lower risk for global growth prospects, especially in the US, means that the likelihood of the US dollar to keep plunging in value as was the case last year is reduced. For us, this implies more exchange rate stability, at least in terms of less frequent large downward swings in the US dollar vis-a-vis the Thai baht. Second, with a more stable US dollar and US financial market performance, there will be less asset price inflationary pressure from the QE2 effect than was anticipated, as the attractiveness of emerging market assets will likely decline somewhat. So far, it does seem like investors are "rebalancing" their portfolios instead of acting on risk sentiment like before.
Back at home, our economy is growing strongly and the momentum is likely to carry into 2011. This coupled with a more stable external environment, as described above, implies that monetary policy will have greater flexibility to keep inflation within target, as the trade-off between output and inflation becomes less complicated. This timely development comes at a time when monetary policy normalisation is ongoing and greater inflationary pressure is being felt.
The December figures for headline and core inflation rose more than expected to 3.0 per cent and 1.4 per cent, respectively, with higher pass-through from rising production costs, which is expected to continue into 2011. In this regard, the MPC has just raised the policy rate by another 25 basis points at its last meeting.
Although confidence is higher in stability abroad, this does not mean risks have dissipated, as noted above. Sudden movements of capital in both legs cannot be ruled out and policymakers must remain vigilant as we continue to watch the rest of the stories in US and Europe unfold.
One lesson from this still-not-over crisis is that price stability alone is not enough to secure financial and economic stability.
At the Bank of Thailand, we have a financial stability framework, which is an inter-departmental effort to monitor the "lessons" or implications of stories such as this one. Various indicators and tools are utilised to identify and assess risks, including a macro-surveillance framework for key economic and financial sectors and stress-tests. The concerns of each department are reported to an internal subcommittee, which then synthesises the different views and makes recommendations to appropriate decision-making committees.
2011 started everyone off better spirited, but it will surely keep us on guard as we move away from supporting recovery towards "rebalancing" growth and stability.
The opinions expressed in this article are the author’s own and do not necessarily reflect the official opinion of the Bank of Thailand.