World Outlook and Challenge of Managing Capital Inflows
Last week Nation Multimedia Group hosted a debate between Deputy Prime Minister and Finance Minister Kittiratt Na-Ranong and former finance minister of the Abhisit administration, Korn Chatikavanij. The debate was billed as "competing visions on the nation's future".
The Nation daily newspaper reported that the debate covered a number of issues ranging from exchange rate management, interest rate policy, budget and the national debt, the efficacy and quality of government expenditure programmes, to public investment in infrastructure, education and rice subsidy policy. The debate was timely as the International Monetary Fund (IMF) had just released its flagship World Economic Outlook last week at the annual meeting organised by the World Bank Group and the IMF.
The main theme of the World Economic Outlook is that global economic prospects have improved but unevenly. The overall world economic output (gross domestic product) is expected to grow at 3.3 per cent in 2013 and 4.0 per cent in 2014. According to the IMF, the economic recovery has moved from a two-speed to a three-speed recovery. Emerging market and developing economies continue to be the main driver for the world economic recovery, expecting to grow at a healthy 5.3 per cent and 5.7 per cent in 2013 and 2014 respectively.
For major advanced economies, there is a bifurcation with the United States in the lead, forecast to grow at 1.9 per cent in 2013 and 3.0 per cent in 2014, while the core Euro area, except Germany, is expected to show a contraction of 0.3 per cent in 2013 and 1.1 per cent in 2014. Germany is forecast to expand at 0.6 per cent in 2013 and 1.5 per cent in 2014. Other advanced economies - Japan, the United Kingdom and Canada - are forecast to have small growth. Japan, with its expansionary monetary policy and structural reforms, is expected to accelerate its growth performance modestly from 0.2 per cent in 2012 to 0.7 per cent and 1.5 per cent in 2013 and 2014. The UK with its continued austerity, and resisting the IMF's call for more stimulus, is forecast to grow at an anaemic pace of 0.7 per cent and 1.5 per cent in 2013 and 2014. Canada's growth is forecast to slip from 1.8 per cent in 2012 to 1.5 per cent in 2013 and 2.5 per cent in 2014.
Emerging and developing Asia is expected to lead the economic recovery and lay the foundation for growth and prosperity. The IMF is forecasting China to grow at 8.0 per cent and 8.2 per cent in 2013 and 2014. The numbers appear to be slightly higher than what the Chinese authorities have just released. Asean+5 (Indonesia, Thailand, Malaysia, the Philippines and Vietnam) as a group is forecast to grow at 5.9 per cent in 2013 and 5.5 per cent in 2014. Thailand is forecast to reach its pre-flood growth rate of 5.9 per cent in 2013 and slow down to 4.2 per cent in 2014.
As Asia is growing at a healthy pace, is well integrated into the global economy through trade and capital markets and as Japan has joined the US and the Euro area in easing its monetary policy stance, it is certain that there will be spillovers of capital into Asia and Thailand. Unlike the globalisation of trade, which generally has a positive impact, financial globalisation has had mixed results as evidenced, among others, by the Asian financial crisis of 1997-99, which included Thailand, and the 2008 global financial crisis whose aftermath is still with us.
The main challenge for near-term macroeconomic management is how to handle the increased capital inflows and the concomitant implications on macroeconomic and financial stability and growth. However, before the Bank of Thailand (BOT) rushes into adopting any capital control measures as some have urged, it would be critically important to analyse and assess the situation. The BOT is in a better position than most commentators and vested interest groups to provide evidence-based analysis of the situation since it has detailed information and knowledge. The analysis should pose some tough questions. Among them are the following:
First, what is the nature of capital flows into Thailand? All capital inflows are not the same.
Capital flows associated with foreign direct investment are generally less volatile than short-term, portfolio and speculative (hot money) capital flows. The challenge for the BOT is to monitor closely what happens in the global economy, to distinguish between different forms of capital inflows and to note how they are absorbed.
According to the IMF's forecast, the ratio of net private foreign direct investment to private portfolio flows to developing Asia this year is about 3:1. Of course, the BOT is in a much better position to monitor and update the composition of capital flows into Thailand.
Second, presumably the concern about the baht's appreciation is Thailand's export competitiveness. Is the nominal bilateral exchange rate with respect to international reserve currencies, such as the baht/US dollar exchange rate, an appropriate measure of competitiveness? The answer is no. The appropriate measure should be the nominal, trade-weighted effective exchange rate. According to the latest World Bank Global Economic Prospects, on average, bilateral exchange rates relative to the US dollar in many developing countries were 22 per cent more volatile than the nominal, trade-weighted effective exchange rate. Again, the BOT should be in a better position to provide analysis and assessment.
Third, are the inflows of capital and the associated appreciation of the baht part of the rebalancing and adjustment process reflecting Thailand's current account surplus and other economic fundamentals?
Thailand has well-developed supply chains and the baht's appreciation lowers the cost of imports. The rebalancing and adjustment process may help reduce the overdependence on exports for growth by increasing domestic consumption.
Finally, all capital controls involve a degree of distortion. What forms should they take in order to minimise any distortions if necessary? Should the policy measures be price-based or administratively set? How should these measures be targeted and what institutional support may be necessary?
Thailand has an adequate reserve buffer and current account surpluses that allow it to approach these questions based on sound analysis. The BOT should maintain its independence and resist the urge to rush into half-baked policy measures.
Kiertisak Toh is a former senior foreign service officer with the US Agency for International Development. He is a member of the economics faculty at Radford University in Virginia and a senior fellow at the Duke Centre for International Development at the Sanford School. This commentary was originally published in The (Thailand) Nation.