Japan Leading Indicator November 2007

Japan's broadest indicator of future economic activity was down again this month, the fourth cosnecutive weak showing, suggesting that the what has been the longest expansion in more than 60 years may well now be coming to an end. The leading index was at 10.0 percent in November, the Cabinet Office said today in Tokyo. A reading of below 50 signals slower growth in the next three to six months.



Weak domestic demand and consumer consumption as Japan's population and workforce steadily age leave the economy increasingly dependant on export growth and overseas demand. To date the slowdown in US demand has been comensated by growth in Europe and China, but now there are clear signs the Chinese authorities really will have to throw the brake on growth this year as iflation gets steadily out of control, while the slowdown in Europe is now gathering speed more rapidly than the one in the United States. Goldman Sachs Group today cut its estimate for Japanese growth in 2008 arguing that slower export demand has put the risk of a recession in Japan at a "danger level". Goldman cut their growth forecast to 1 percent from 1.2 percent and said the Bank of Japan will have to forego any interest rate increases until next year. I would go further. I would say that a recession in Japan is now a foregone conclusion. The only real question is how deep and for how long. 1% growth may well be on the optimistic side, and I would start out at 0.5% and subject to downward revision. On the BoJ, as Claus says, it isn't so much that they won't raise as when are they likely to cut, and when will we be back (yes, that dreaded word) to ZIRP.

Japan has had three recessions since the country's stock and property bubble burst in the early 1990s. The first lasted 32 months from March 1991 to October 1993, while the second dragged on for 20 months from June 1997 to January 1999. The most recent recession was in the 14 months from December 2000, following the bursting of an information-technology boom. So all the indiactions are that this recession will not be a short affair. It needs to be borne in mind that each time round now Japan's population is older, and the fragility of the underlying situation proportionately greater.

As Claus was indicating in his recent post, there is probably now going to be a certain monotony in the data here, as it all moves - sometimes more slowly and sometimes more quickly - in the same direction. The centre of action is now likely to move to the political stage and to following how the Japanese population react to yet another disappointment.

``We project weaker-than-expected growth in the first half of 2008 owing to an inevitable, moderate slowdown among emerging economies,'' said Tetsufumi Yamakawa, chief Japan economist at Goldman Sachs in Tokyo.

India Inflation December 22 2007

India's inflation held below the central bank target for a sixth straight month as the government continued to keep a cap on fuel prices despite the fact that global crude oil surged to a record. Wholesale prices rose 3.5 percent in the week ended Dec. 22 from a year earlier, faster than the previous week's 3.45 percent gain, the Ministry of Commerce and Industry said today in New Delhi.




The Indian government may raise auto fuel prices by the end of January for the first time in 18 months according to Oil Minister Murli Deora yesterday. That could reignite price pressures and prompt the central bank, which targets 5 percent inflation, to keep its benchmark interest rate at a 5 1/2-year high at its Jan. 31 monetary-policy meeting.

India imports almost three-quarters of its energy needs, and has not allowed increases in fuel prices even as crude oil prices have risen 79 percent from a year ago.

The government caps gasoline and diesel rates to help keep inflation down and protect the poor, who make up half the country's 1.1 billion people. Gasoline and diesel prices were last changed on Feb. 15, when they were cut for the second time in 2 1/2 months. Cooking gas prices haven't been raised since November 2004 and kerosene since April 2002.

Inflation in the third week of December rose as the index of fuels, with 14.2 percent weight in the inflation basket, rose 0.5 percent and the index for manufactured products, including sugar, cement and edible oils, rose 0.1 percent.

Rupee Near Record

The rupee climbed again today to reach its highest level in almost a decade as the benchmark stock index rose to a record, raising expectations global funds will buy more local equities. The rupee gained for the fourth successive day after Citigroup and Deutsche Bank said in research reports that the Bombay Stock Exchange's Sensitive Index, or Sensex, will add to gains for the seventh year in a row as a near-record pace of economic growth boosts company earnings. Prime Minister Manmohan Singh today said ``conditions are favorable'' for the nation to sustain a growth rate of between 9 percent and 10 percent in the next five years.

The currency gained to 39.275 against the dollar at the 5 p.m. close in Mumbai, the highest since Feb. 26, 1998, according to data compiled by Bloomberg. It closed at 39.295 yesterday. The rupee, which last year posted the biggest annual gain since at least 1974, may reach 39 this month according to many observers.

Merry Xmas and A Happy New Year

Well, a Merry Xmas and a Happy New Year to all my readers. Thank you for taking the time and trouble to pass-by. This blog will now - failing major and surprising new developments in the global economy - be offline till the end of the first week in January, or till after the festival of Los Reyes Magos in Spain (for those of you who know what this is all about). Come to think of it, maybe this is just what our ever hopeful central bankers are in need of even as I write - some surprise presents from the three wise men - but I fear that this year if these worthy gentlemen do somehow show at the next G7 meet, the star in the east which draws them will not be the one described in the traditional texts, but in all likelihood the rising star of India.



Credit crunch, did someone use the expression credit crunch?

Japan in 2008 ... ZIRP Coming Closer?

by Claus Vistesen

None of the writers here at Japan Economy Watch are professional forecasters and analysts per se. Yet, with what seems to be happening 'next' in Japan I can not help but think that you have been extraordinarily well served here at JEW during the past year. As such, let us have a look at what I said on Japan (and indeed the global economy) about a year ago as we stood on the brink of 2007.

(...) we have the Top 10 of economic predictions for 2007 by Global Insight where the chief economist Nariman Behavesh argues that the BOJ is likely to have raised to 1% by the end of 2007; this would then imply three 0.25% steps from the current level 0.25%. As you will see this is a part of a broad discourse concerning how global interest rates differentials will narrow as the Fed is going to cut while the BOJ and the ECB are going to raise; for the record I do not see this happening at all!

Now, the ever perceptive readers of this blog will immediately notice the apparent rather peculiar reason as to why I am feeling so smug in my introduction. In this way and apart, of course from the BOJ raising to 1%, isn't this thing of 'narrowing' of global interest rate differentials exactly what we have seen? It could indeed seem so as the Fed's aggressive easing have coincided with a fixed stance in Japan and increases moving over to holding operations at the ECB. However, this is also where I would like to start the whole 'what will happen in 2008' debate since how sustainable is this current state of affairs amongst the three G3 economies? Well, as for the US they have already bitten the bullit. The subprime mess is still pounding away with the recent victims being Morgan Stanley and Bear Sterns having to push the big delete button on a slew of internal balance sheets as it became clear that the subprime debacle had claimed yet another score of assets. But the US economy in general and while certainly still on the ropes is on its way to get to grips with its new situation and get on with the fight. I won't even begin to rant on the Eurozone here where I fear that 2008 will be a year of many a camel swallowing (or was that cold pouridge?) by those who have been pushing the Goldilocks narrative the hardest. Let me move swiftly over to Japan where as can readily be seen the BOJ has not managed to raise the short term interest rate to 1%, far from it actually. I should note in this context that I am not trying to pound excessively on Global Insight and its chief economist who I am sure is a very able and smart analyst. I am simply trying to hammer down that the consensus on Japan as it emerged from 2006 has not exactly materialised and what we now need to do is to understand why as well as we need to look forward as to what will happen next. I will begin with the latter question as Bloomberg today carries a piece on Japan where it is actually suggested that the BOJ will have to lower rates which effectively would take them back into ZIRP ...

Toshihiko Fukui's final act as governor of the Bank of Japan may be to cut borrowing costs for the first time in more than six years. Economists began predicting Fukui, 72, will have to lower rates after the Bank of Japan yesterday downgraded its assessment of the economy for the first time in three years. The bank has raised rates twice since July 2006, when it ended a policy of keeping borrowing costs near zero to beat a decade of deflation. ``They may have to cut,'' said Robert Feldman, head of economic research at Morgan Stanley in Tokyo. ``As Fukui said yesterday, the economy is getting worse.''

This is of course far from being a done deal but it is interesting to see how the discourse kicked off in 2006 with sustainable recovery stories flying all over the place to now where it seems as if we have come full circle. What I particularly want to emphasise here is that this Felman talking and when he says something on Japan people all over the place are bound to listen carefully. Whether the BOJ will actually go ahead with a return into ZIRP is difficult to say indeed. The point is that while economic factors will indeed be importants determinants so will political. The BOJ stands before a change in leadership in Spring 2008 and given the current spout of political uncertainty lingering in Japan combined with fierce debate over potential future 'un-popular' political measures (e.g. a consumption tax perhaps?) any decision and especially one downwards in the interest rate is bound to be surrounded by much commotion not least from the external environment where the G7 is sure to be jumping and dancing all over the place in the event of a cut. This brings me to the other question raised above and one which is far more fundamental and important. As such, why is it that Japan did not see that sustainable recovery? The first thing to bear in mind is clearly the fact that the financial turmoil which was brewing in the beginning of 2007 reared its head with much more force than most had anticipated. There is no doubt that this has not exactly been accomodative to the Japanese economy. However, what I really want to home in on is the narrative which has emerged here in the twilight of 2007 as it has become clear that Japan will probably be flirting with a recession. In this way, it seems that whatever happens next in Japan with respect to the inevitable slowdown of economic momentum is bound to shore up exclusively at the politicians' door. Now, this is an extremely dangerous path to go by I think as I also noted recently (for good measure, Takehiro Sato's 'Buckle Up' analysis can be found here). Edward also treats this point in one of the post which immediately preceedes this one where the following point is worth pondering ...

For anything to work for you in life you need a certain amount of good luck, and when your luck is down, and the level of adversity you face mounts, then the problems only seem to pile up. This perfectly describes Japan present problem set I think (I mean don't forget the famous pensions-records scandal, which seems to have been all but forgotten at the moment, except by the people who had their records lost, of course). If you really could live without a spanner showing up in the works, then it never fails to show up. That's what we mean by being "down on your luck". As Jefferson said, when I find myself being lucky I am normally sitting here, hard at work at my desk. That is, we make our own luck, using foresight and sound policy.

In this way and to paraphrase one of pre-modern history's most vexing questions on whose altar many a head has been severed from its body we need to ask whether the sun revolves around the earth or whether in fact it is not the other way around? Of course, no heads will be severed this time around which serves to indicate the strides human intelligence and community have made after all. So, leaving you with these arcane matters I might risk coming off as a scrooge here just before Christmas. This was not my attention but I do think that we need to think long and hard about what cause and effect are in terms of analysing the Japanese economy.

I will have more later on the actual market implications of all this and do have a Merry Christmas come next week.

Capital Inflows into India and Rupee Appreciation

Well, this is headed I think to become topic of the year again in 2008. Arpitha Bykere has a post up today on RGE Monitor, and I had a piece on Friday up on India Economy Blog.

I think here that perhaps three charts tell it all. First we have the capital inflows themselves:



And then secondly we have the changing relative dollar values of global GDP, which is a topic that takes us straight into the whole debate about "decoupling" and "recoupling". Basically there seem to be two versions of the "decoupling" thesis knocking about. The first of these (which is now very definitely going out of fashion very fast) was based on the idea that the global economy was finally decoupling itself from the US one due to the fact that key global engines among the G7-type economies - and in particular Germany and Japan (and following in both cases lengthy periods of structural reforms) - were finally coming out of a long period of sub-par economic growth and achieving "home grown", domestic-demand-driven, sustainable recoveries in a way which would enable them to take more of the global strain

But there is another sense of "decoupling" (which is the one Claus Vistesen and I prefer to call "recoupling" - although this is not, it should be noted - recoupling in the way in which Nouriel Roubini (for example) uses the expression, which seems to refer to some form of renewed coupling to a US economy which is basically on its way down, not in GDP growth terms - although there may of course be a recession - but in dollar share of world GDP terms) and this is to do with the way in which certain emerging market economies (the EU 10, Ukraine, Russia, China, India, Turkey, Brazil, Argentina, Chile etc) are now accounting for a very substantial proportion of global growth (Claus and I have yet to do the detailed numbers on this, but suffice it to say that India, China and Russia alone will account for over 30 % of the growth in the global economy in 2007). This is a far cry from the central role which the US economy was playing in global growth in the late 1990s. So in this sense something fundamental has changed, and this is what Claus and I are calling "recoupling".

This situation can be observed quite clearly in the two charts which follow, which are based on calculations made from data available in the IMF October 2007 World Economic Outlook database. Now, as can be seen in the first chart the weight of the US economy in the entire global economy has been declining since 2001 (and that of Japan since the early 1990s). At the same time - and again particularly since 2001 - the weight of the soc called BRIC economies (Brazil, Russia, China and India) has been rising steadily. This is just one example - and a very crude one at that - of why Claus and I consider that demographics is so important, since it is precisely the population volume of the BRIC countries (and the fact that they start their development process from a very low base, ie they were allowed to become very poor comparatively, for whatever reason) that makes this transformation so significant.

Again, if we come to look at shares in world GDP growth we can see the steadily rising importance of these economies in recent years and the significantly weaker role of "home grown" US growth. The impact of the collapse of the Tech stocks/internet boom in 2001 is clear enough in the chart, as is the fact that everyone went down at the same time, and this is the old form of "coupling" wherein the US economy due, to its size (and hence specific weight) and "above-par" growth potential played a key role, and, as can be seen, when the US went down, then god save the rest. The present debate is really about what will happen if the rising dollar cost of oil and the ongoing difficulties in the financial sector caused by the sub-prime problem leads the US into recession in 2008. Will everyone else follow this time? In 1999 the US economy represented 30.91% of world GDP, and in 2007 this percentage will be down to 22.4% (on my calculations based on the forceast made by the IMF in October 2007). In 200 the US economy accounted for a staggering 40.71% of global growth, and by 2007 this share is expected to be down to 6.43%. So there are prima-facie reasons for thinking that this time round the impact of any US slowdown will not be as acutely felt in some parts of the globe as was the case in 2000, but which parts of the globe will be more affected and which less so?

So now back to those capital flows. As Arpitha Bykere points out, the rupee rose by around 15.5% against the dollar between Sep 2006 and Oct 2007. The RBI and Indian government have been busying themselves trying to use the various tools they have at their disposal to try to manage the inflows and their potential impact on liquidity and inflation with a variety of forms of FX intervention and sterilization.



Bank reserve requirements have been raised eight times this year, from 5% in December 2006 to 7.5% in October 2007.



The repo rate been raised seven times from 6% in April 2005 to 7.75% in March 2007 while the reverse repo rate has been increased five times from 4.75% in March 2004 to 6% in July 2006.




The increase in reserve requirement acts as a kind of tax on banks (and this makes their work even more difficult for them to increase their deposit base given the pressures for funds which exist in the consumer market and the attractive returns available elsewhere. Further, RBI rules that effectively force them to hold a quarter of their deposits in govt bonds and to purchase the low return sterilization bonds make for added pressures in the conventional banking sector).

India's central bank on December 14 also curbed bank loans to mutual funds by mandating that these loans will be treated as lenders' direct investments in stock and bond markets. The central bank has also accelerated the pace of the sterilization via issuance of market stabilization scheme (MSS) bonds. Using such techniques the RBI has managed to sterilize about 58% of the foreign inflows, according to estmates by Chetan Ayha. The sterilized liquidity (excess liquidity) stock - which includes reverse repo less repo balances, MSS bonds, government balances with the RBI and the increase in the cash reserve ratio - has shot up to US$77 billion as of end-October 2007 from US$19 as of end-October 2006, according to the same estimates.

Banks are currently required to limit investments in capital markets to less than 40 percent of their net worth, while funds may borrow from banks only to meet ``temporary liquidity needs'' and as per the capital market regulator's guidelines.

This move was a response to the discovery by an apparently astonished RBI that the financial records of some banks showed they had extended "large loans to various mutual funds and also issued irrevocable payment commitments to stock exchanges on behalf of mutual funds and foreign institutional investors". Such transactions were found to have been widespread, but were not included by the banks as part of their declaration of capital market investments.

As a result the Securities and Exchange of India has ruled that a mutual fund may borrow only up to 20 percent of its net assets and for periods of not more than six months.Also the RBI has ruled that banks must not give loans or other forms of financial assistance, such as payment guarantees, to foreign institutional investors. Domestic banks have now been given six months to comply with the instructions.

RBI’s control over monetary policy has evidently been gradually weakening. Initially RBI followed an independent monetary policy of targeting the interest rate while maintaining a competitive exchange rate with partial capital controls. But as the economy has gradually accelerated to around a 9% average over the last three quarters, and as the sub-prime blow out has added to the attraction of strongly growing emerging economies with relatively higher interest rates and the prospect of strong relative currency apprecaiation, the consequent ineviatable arrival of large capital inflows has lead to RBI to acquiesce its ongoing appreciation, and control over the value of the rupee has to some extent been sacrificed in an atempt to keep control over the interest rate. But as the rupee has steadily approached the 40 USD pain threshold level the RBI has shifted its efforts towards control over the capital account, imposing soft controls on inflows and easing outflows. Moreover, the use of interest rate is constrained by concerns about unnecessarily slowing growth in one direction, and accumulating inflationary pressure (including food, manufacturing, asset inflation) in the other.

In theory the RBI could allow exchange rate appreciation to offset the liquidity injection (buying dollars and selling rupees, for example). But a case can well be made that the Indian exchange rate is already somewhat over-valued. The 36-country real effective exchange rate was about 8.5% above the ten-year mean as of September 2007.





More importantly, the 12-month trailing trade deficit has shot up to 6.7% of GDP as of September 2007, resulting in an adverse impact on job creation in the manufacturing sector. Total goods exports growth has decelerated to 4.3% in rupee terms as of September 2007. In our view, small and medium enterprises would have been growing at an even slower rate, as the large companies would have been able to maintain their growth better.

Even if one were to consider the services sector exports, the trailing four-quarter sum of the current account deficit (excluding remittances) is at 4.2% of GDP as of June 2007. The headline current account deficit, however, is at a manageable level of 1%, primarily on account of the rising remittances from non-residents. The four-quarter trailing sum of non-residents’ remittances has shot up to US$30 billion (3.2% of GDP) as of June 2007. For assessing the impact of the exchange rate on the domestic output balance, we believe that we should exclude remittances, which represents transfer of income generated in foreign countries. Having to stand back and watch any further appreciation of the exchange rate will be a testing moment for policy makers considering the potential adverse impact on domestic growth and job creation.

Another important source of capital inflows has been Portfolio Investment which rose from $2.8 b in FY2000 and $12.5 b in FY2005 to $18.5 b Apr-Sep 2007. According to the IMF Foreign Institutional Investment (FII) has risen from $1.8 b in FY2000 to $8.7 b in FY2004 and to $15.5 b during Apr-Sep 2007. Moreover, the number of FIIs registered in India doubled to 1,050 between Mar 2001 and Jun 2007, and there are now around 3,336 FII sub-accounts. FII equity inflows have increased from $9.8 b in 2004, to $11 b in 2005, and now to over $16 b in the year so far of 2007.

India's stock market - buoyed by strong corporate performance and the aforementioned inflows - has risen 43% to date in 2007. According to Citigroup, FIIs holdings in the Bombay Stock Exchange 500 companies rose from 12% in March 2001 to around 22% in June 2007, which is greater than the holdings of domestic mutual funds.

In mid-October, the RBI reacted to some of this by banning foreign investment in the stock market via off-shore derivatives in the form of Participatory Notes (PN). Such derivatives had been habitually used by foreign investors who were not officially registered in India (say hedge funds) to indirectly invest through registered investors. Between Mar 2004-Aug 2007, the number of FIIs/Sub Accounts that issued PNs rose from 14 to 34. The share of PNs in total foreign portfolio flows is believed to have increased from 32% during 2006 to about 55% by Oct 2007, with hedge funds accounting for around 50% of the PNs. It has, however, been suggested that the real motive behind the October RBI measure was not so much to restrict investment as to improve the transparency of capital inflows and that restricting inflows via PNs is likely to have little or no impact on the overall inflows entering India in the medium term.

Hedge and mutual and pension funds activity have all been growing in India. Hedge fund investment in India has risen 400% from $2.8 b in Sep 2005 to $13.97 b as of July 2007 with over 90% of these investments in equities accruing high returns. According to the Financial Times, private equity deals have surged from $3.9 b in 2006 to around $ 5.9 b ytd in 2007.

FDI has also risen significantly from the low level of $3.8b in FY2004 to $16 b in FY2006. In addition, cross border M&A deals increased to 226 deals worth $15.3 b in 2006 from 192 deals worth $9.5 b in 2005. More importantly, investment by non-resident Indians in foreign currency deposits and rupee accounts has risen over the years from $21.7 b in FY2000, $33 b in FY2004 to $41.2 b in FY2006, leading the RBI to cap interest rates on the latter. Moreover, remittances have increased from $12.9 b in FY2000 to $20.5 b in FY 2004 and $27.2 b in FY 2006.

According to the IMF India's external debt rose 22.6% to $155 b in FY 2006 (with the appreciating rupee contributing to 10% of this increase) and now is equivalent to 16.4% of GDP. Around 56% of the increase in external debt was due to ECBs and 16% of the increase was due to NRI deposits. India's Net International Investment Position has improved somewhat in the recent years due to increase in assets (rising outward FDI), even as liabilities have continued to grow. Rising FDI and equity portfolio inflows have helped non-debt creating inflows to rise from 27% in FY2000 to 47% in FY2006, but FDI inflows are only up from 14.7% in FY2000 to 25% in FY2006.

Thailand's Economy - At a Crossroads?

by Claus Vistesen: Copenhagen

As we never tire of pointing out here at this space the analysis and proper understanding of the global economy and more specifically her markets demand a vigorous interaction and -play between the overall broad conceptual analysis and the more nitty-gritty country analysis. Today, and as most people, in the Western World at least, rev up for some of that most scarce and precious quality time with friends and family I feel inclined to wander off over to Thailand for one last spout of economic analysis before closing down for the holidays. Before I start I think it would be only fair to point out that I am not exactly an expert when it comes to Thailand's economy but rather I shall progress in the spirit of traditional writings here at GEM where authors attempt to aspire to the ideal and tradition of the polymath rather than towards the profile of the 'genius savant' in one specialist area.

Yet, and despite my denial of expertise in the area of Thai economics I think it is safe to say that Thailand commands a rather special place in the whole global economic framework for two main reasons. The first is strictly endogeous to political life in Thailand, where the frequency with which governments are toppled by the military only to be subsequently re-inserted (with a quick change of label), is rather high when compared with most other members of the emerging economies leading group.

The lastest example of this tendency was handed to us a little over a year ago when General Sonthi Boonyaratglin ousted prime minister Thaksin Shinawatra and declared that a military junta would stay in power for a year. Such abrupt changes of government (and of course the way of changing them) have a tendency not to go down too well with foreign investors and naturally have tended to affect the ability of Thailand to attract foreign capital inflows, as well as to act as a source of outflows. Of course, many would, at this point in time, simply exclaim that since these things are now a natural part of the political cycle in Thailand they are already well priced-in to current market premiums. I will leave this issue here and simply note that whatever importance we ascribe to the political situation in Thailand, an interventionist military is certainly part of the picture and needs to be taken into account.

The second reason for Thailand's rather special position in the international economic environment is to be found by going back to 1997 and the Asian currency and financial crisis. As I am sure many of our readers remember Thailand acted was one of the principle centres of attention during the boom phase and then one of the victims of the sudden and abrupt retrenchment of private inflows to emerging markets which occured during the Spring and Summer of 1997. This would then translate into a modern day 'once bitten twice shy' mantle and although I am unsure whether this actually applies for Thailand it serves us well always to remember that debating capital flows in the context of Thailand always will tend to have that historical glow around it.

Where now for Thailand?

In order to deliver a reasonable crack at answering this after all very general question I need to invoke the headline of this note. In my opinion and as I will try to argue below Thailand is now at a crossroads. On the one hand Thailand finds itself right smack in the middle of the sweet spot relative to the ongoing demographic transition known as the demographic dividend. As we know this does not by any means constitute free lunches - of which, of course, there are very few, if any - but rather a golden opportunity for Thailand to move now in order to make sure that it does not go down the road of other rapidly ageing emerging economies of which China is perhaps the most important and best known example. However, if Thailand is to get rich before she actually gets old the window is closing fast.

By inspecting the graphs over at the Thailand Economy Watch we can readily see that Thailand with respect to its demographic position is now borderline between two extremes. The fertility rate has been stable at about 1.6 for the past 8 years and coupled with a rapid increase in life expectancy (which of course is a good thing) Thailand is now set to age rather rapidly. However, the effects of the ageing process are likely to be subdued in the interim as Thailand will enjoy something like 15 years of demographic headwind before reaching that ever so important 40 year median age threshold. Now, and although I realize that I have not yet fielded one single economic chart let me be very clear. A great deal of Thailand's economic future rests upon whether the economic growth which is now set to come and continue all things equal will bring Thailand a further notch into the demographic transition bringing TFR below the 1.5 mark. I really hope not and if there ever was an important objective for policy makers in Thailand it would be to make sure that what comes next is accompanied by an effort to keep the fertility rate from falling further, and preferrably, to find ways to nudge it back up to a slightly higher level. This would then bring me back to the present, which is what indeed is set to happen next in the context of the global and thus the Thailand economy?

Let us begin with a kind of overview of the Thailand economy such as it. As we can see from the two graphs fielded below, Thailand's prosperity has done been on the rise over the past 15-20 years, - a much more modest rise following 1998, but a rise nonetheless - and there is really no reason to believe that this will not continue to be the case in the immediate future. The Asian Crisis as it occured in the 1997-1998 is certainly not absent from the charts and you could even, if you are into such matters, debate whether in fact Thailand suffered an irreversible blow to its growth trend back in 1997? For more on this topic go here.

As for the short term economic data on Thailand, the most recent central bank inflation report (PDF) provides us with ample ammunition to get a more solid grip on the immediate outlook. If we scrutinize the data a bit more closely we see that growth in Thailand seems to have moderated somewhat when it comes to the evolution of headline GDP. This slowdown which must be considered in relative terms has coincided with a subtle but important change with respect to the engine of headline GDP growth. As can readily be seen from the chart the central bank provide (reproduced below) as private consumption and fixed capital formation have waned net exports of goods and services have slowly but surely been taking over as the main engine of economic growth in Thailand.



This is of course an important trend to take into account since it does mean that Thailand is subject to the whims of global markets to a higher degree than had been the case if private consumption had been doing the heavy lifting. Clearly, at this point we should remember that the time-span in question (i.e. Q2 2006 to Q3 2007) is exactly the period where domestic political uncertainty took a hefty leap upwards. So, it is really difficult to discern a notable trend in all this. However if we look at the central bank's private consumption index we can see after a slowdown at the end of 2006 (which would be associated with the political uncertainty) things do now seem to be turning back up again, so we may well be in a recovery phase.



Another notable feature of the recent trends in the Thai economy is the rather subdued rate of inflation which has come down over the course of 2006 and now into 2007/2008 as well. This seems somewhat odd when you look at the figures on the labour market where it quickly becomes clear that Thailand is firing on all cylinders at the moment with a monthly registred unemployment rate below 2% and somthing like 35 million people in work out of 64 million inhabitants. Indeed between the summer of 2005 the summer of 2007, Thailand added the best part of a million new jobs. This is really what the demographic dividend is all about, enabling rapid employment growth without provoking inflation. The demographic dividend isn't a policy, but it does produce an environment which is more favourable to the application of good policy.

This could indicate then that if consumer spending and confidence continue to enjoy a rebound, and if the political situation has reached some sort of resolution then the inflation gauge might start to tick upwards as we venture into 2008, especially in the light of the general global tendencies in base commodity and food prices. Finally, we have as I have already hinted above the trade surplus which since Q3 2005 has averaged around 15% of GDP offers Thailand a firm buffer for solid headline growth.

This then serves us to move further into the argument in this note and as such to the more specific point on capital flows which are central for the understanding of the current changes in the global economy and thus also Thailand.

Capital Flows and Thailand - To Receive or to Send?

Starting out with capital flows in the global economy I recently narrated the current economic climate as fairing in uncharted waters given the delicate situation in which we are now finding ourselves. This uncharted waters theme should not however be misinterpreted as lack of oversight which I feel we at GEM have plenty of. Rather, we are simply noting that what happens next will be an important test for many of our theses and arguments. In this way and homing in on what is especially important in the context of Thailand we have the mounting signs and evidence that the structures and chains of Bretton Woods II are slowly but surely being worn thin. These changes however do not seem supportive of those who have spent their time arguing for a process of de-coupling in the traditional sense whereby the US hands over the baton to a train being run by a joint tag-team consisting of Europe and Japan.

Moreso, what we are seeing is a historic process of re-coupling by which the engine locomotive of the global economy is changing from being driven exclusively by the US towards a more diverse crowd of leaders. How far this process will go on is yet to be seen. I for one don't envision for example that the US will revert entirely to growth path where a substantial external deficit is not part of the overall picture. But the main point is that the relative weight will change and perhaps more importantly that the changes we are now seeing are happening at a pace which is quite unprecented. Of course, as Brad Setser is set on hammering home a lot lately, the recent retreat of financing from the external US balance is largely due to an almost effective stoppage of private inflows which of course has the nasty side effect that the US is now ever more so dependant on official foreign government inflows in order to keep the boat floating. As for the general situation, the following wonderful quote from Setser quite eloquently sums up how we are now situated in somewhat of an interim position

Private investors want to finance deficits in countries that don’t want to run deficits. The countries now accumulating reserves the fastest have the least need for reserves. The country with the largest deficit is struggling to attract enough private inflows to match the increased desire of its private sector to buy foreign assets – let alone both the deficit and those outflows. And the country with the strongest traditional aversion to state-ownership is now the country most-reliant on government inflows.

As I mentioned above Brad Setser seems to be focusing quite a lot on the apparent disconnect between private and government/official flows with respect to the financing of the US CA deficit. This rather specific topic should be the center of another note and here we should rather move on to the obvious question. Given that changes are taking place of almost tectonic proportions in the structure of global capital flows what will this mean for Thailand? To deliver a reasonable attempt to answer that question I will need to field some grahps of which some, I am afraid, will be plotting some rather technical stuff. But I will explain as I go along. Let us first inspect the basic graphs plotting the CA balance and financial account as it has evolved on a quarterly basis since 1995. Note that these two are inversely correlated as the former measures the headline balance between flows of funds, goods, and services whereas the latter plots the net change in foreign ownership of domestic financial assets. This basically means that if the financial account is in surplus foreigners are buying domestic financial assets more quickly than domestic agents are buying foreign assets and vice versa of course if we are talking about 'selling.'

Once again, we can easily see when the Asian Crisis occured in the beginning of 1997. Other things to note is the fact that volatility seems to have returned to the overall CA balance in the recent years which is something I will talk a bit further about below. Secondly, and following from this point we see that foreign investors seems to have once more become rather fond of putting their funds in Thailand over the last couple of years as compared with the relative stagnation in the years following the currency crisis. This is can be further substantiated by a chart showing the flows of net portfolio investments.

As can be seen particularly well on this graph volatility has indeed returned with a venegance since 2004 and as I hinted this is bound to bring forth that 'once bitten twice shy' mantle. However, and as a testament to the new situation in the global economy the Thailand response to all this was essentially turned upside down when it came the 18th of December 2006. As Edward wrote just as the news was coming in off the wire, the measures to control capital were not designed to stem a potential rapid fall in the value of the Bhat as was the case in 1997. Quite the contrary;

So now we have capital controls, not to stem an outflow of foreign exchange, but to stop an outflow of domestic currency. Oh how the world has changed. Of course, it should escape no-one's notice that with fertility now well below replacement (somewhere in the 1.6 tfr range) Thailand is now right in the middle of that Demographic Dividend/Demographic Transition process I keep talking about.

Indeed, the world seems to have changed and Thailand now must decide how to position itself in this new situation. And this my dear reader brings me back to where I started and how Thailand now seems to be set a crossroads and while it may not be a question of losing your horse or your head, it does seem as if whatever road Thailand chooses it is a choice of some importance. In this way, Thailand seems to be faced with, at least, two interconnected choices moving forward from here. The first issue as I have hinted above is whether Thailand will be able to get the demographic house in order or not. There are of course many unknowns here either way but one thing seems fairly certain at this point. With life expectancy shooting upwards and fertility lingering at a TFR of 1.6 the next 12-15 years of economic development will be very important. If evidence from other countries is something to go by Thailand faces the imminent risk of tumbling down into the sub 1.5 TFR region which essentially constitutes something of a fertility trap. I strongly advise policy makers and others to strive so that this does not come to pass.

The second challenge which stands before Thailand relates to the whole changing structure of the international economic system and essentially the point that what we considered yesterday to be a distinction between developing and developed countries today is nothing but another anachronism ready for the big historical bin. In short, which strategy should Thailand deploy in an environment where liquidity is aflush and where the global search for yield is on? There is no straightforward question to this answer and in particular when we are talking about Thailand you cannot but expect that the old 'once bitten twice shy' dictum to be high on agenda. However, as I have also tried to argue above the times have changed immensely from 1997 and now Thailand is busy keeping money from pouring instead of pouring out. Consequently, it was only back in the beginning of December that we learned how authorities in Thailand were considering lifting capital control following today's elections (23rd of December). This then trickled down onto the jungle drums where echoes of double digit % Bhat appreciation were flying all over the place. Indeed, the Bhat has been on an upwards path as of late against the USD and now as the new government readies itself to take office we shall see what happens.




However, what would my view be on this then? Well, I certainly don't want to come off as being complacent towards allowing money to come in too quickly since when this happens there is always the risk that those very same funds may leave just as swiftly again. Nobody would know this better than those interested in Thailand's economy. However, perhaps we should also take heart of the fact, and as Edward so eloquently emphasised in the context of India recently, that the sands and seeds of time cannot be made to run backwards. At the end of the day you could then ask the most prominent question of whether in fact Thailand has a choice or not? Of course it does, Thailand like India, Brazil, and Turkey cannot just with a simple stroke of a magic wand absorb the procedes of a full scale of re-balancing/re-coupling of the global train. However, trying to stem the tide by building barriers is not likely to do any good either.

Conclusively, I want to finish off by adding that I see a whole lot of potential for Thailand's economy going forward. It is going to be a bumpy ride for sure and wills and wit will be tested but so it is with history and the future. Both of them are very much with us in the present. The last thing I would like to emphasise is the danger that Thailand follows the path of China not, of course, with the one-child policy per se but rather with respect to the path of growth where I clearly see an important link between the two; demographics and growth path that is. Export dependancy it seems, and not as per usual like all good things, will come to those who wait. Let that be a subtle reminder for Thailand as the country equips itself for a new year with new challenges.