Total E Oct08

Inflation Report
October 2008
The Inflation Report is prepared quarterly by staff of the Bank of Thailand with the approval of the Monetary Policy Committee (MPC). It serves two purposes: (1) to provide a clear forward-looking framework for economic and inflation forecasting to assist the MPC in making monetary policy decisions and (2) to give the MPC an opportunity to present the explanation for their decisions on various policy issues to the public. Although individual MPC members may have differing opinions regarding the assumptions on which the forecasts are based, as a group they are in agreement with the forecasts on the outlook for inflation and output as well as the risk factors involved as illustrated in the fan charts.
The Monetary Policy Committee:

Mrs. Tarisa Mrs. Atchana Mr. Bandid Mr. Chakramon Mr. Ampon Mr. Ammar Mr. Praipol Watanagase Waiquamdee Nijathaworn Phasukavanich Kittiampon Siamwalla Koomsup Chairman Vice Chairman Member Member Member Member Member
Inflation Report October 2008
Thailand Monetary Policy Strategy

Monetary Policy Formulation
The Monetary Policy Committee (MPC) sets monetary policy in order to attain price stability conducive to sustainable economic growth. The MPC also monitors factors contributing to external stability and financial imbalances.
The Monetary Policy Instrument
The MPC utilizes the 1-day bilateral repurchase transaction rate as the key policy rate to signal the monetary policy stance.
The Target
The MPC uses core inflation (excluding raw food and energy) as its policy target with the range of 0-3.5 per cent (quarterly average). In the event that the target is missed, the MPC is required to explain the reasons thereof to the public.
Forecasting Tools
To assist the MPC in making monetary policy decisions, the Bank of Thailand has developed a macroeconomic model to forecast economic conditions and inflation outlook. The model is also employed to evaluate the impact of various factors on the economy and to offer guidelines for appropriate monetary policy responses.
Contents
1. Overview
Box: Potential output and the conduct of monetary policy
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7
2. Recent Developments in Inflation and Economic Conditions

Inflation trends Aggregate demand in 2008 Q2 Trend of aggregate demand in 2008 Q3 Production and supply in 2008 Q2 Trend in production and supply in 2008 Q3
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9 12 16 19 21
3. Monetary Conditions in the Last 3 Months

Money market conditions Monetary base and money supply Adjustments of the banking system Exchange rate and capital flows
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25 28 29 34
4. Financial Stability Conditions and Outlook

Non-financial corporate sector Household sector Real estate sector Financial institutions Financial markets Box: Corporate sector vulnerability analysis from probability of default
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39 43 45 46 48 40
5. Inflation Outlook
Forecast assumptions Output and inflation projections Assessment of risks Forecasts by research houses Box: The slowdown of Asian economies
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55 63 67 73 57
6. Conclusion
Report: Economic/Business Information Exchange Program Between the Bank of Thailand and the Business Sector
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1. Overview
The Thai economy in 2008 Q2 expanded by 5.3 per cent yearon-year, a moderation from 2008 Q1 and lower than projected by the MPC in the previous Inflation Report, due largely to the deceleration in domestic demand, both from private consumption and public spending. Private consumption showed signs of moderation in line with the deterioration in consumer confidence and business sentiment, as a result of a marked increase in the cost of living and of production. Public spending also decreased from the same period of the previous year, partly due to less-than-expected budget disbursement. However, the export sector continued to expand favorably, supporting the overall economic expansion.
Table 1.1 GDP at 1988 prices Unit: %yoy Domestic demand1/ Private consumption Private investment Public expenditure Net exports of goods and services Exports of goods and services Imports of goods and services Gross domestic product 2007 Q2 2.4 1.5 0.5 10.8 21.2 7.1 3.5 4.8 1.5 0.9 -0.7 9.3 33.5 7.8 3.0 4.3 2007 Q3 2.9 1.8 1.1 9.5 6.4 3.4 2.6 4.8 Q4 3.7 1.8 3.9 16.0 16.3 8.5 6.2 5.7 Q1 3.1 2.6 6.5 -0.1 4.4 8.7 10.1 6.1 2008 Q2 1.8 2.4 4.3 -2.4 19.0 9.3 6.9 5.3
Note: % yoy = percentage change from the previous year 1/ Domestic demand excludes changes in stocks Source: National Economic and Social Development Board
In 2008 Q3, domestic demand growth continued to show signs of moderation, due to prolonged adverse factors that eroded growth in previous periods. These factors included the deterioration in consumer and business confidence, the gloomy domestic political situation, as well as the continued decline in public spending. However, pressures on inflation moderated to some extent as a result of the downward trend of oil prices, together with the governments measures to alleviate the publics cost of living. The world economy showed noticeable signs of fragility, following the bankruptcy of financial institutions and tightening liquidity in the financial systems of the US and other countries, as financial
institutions became reluctant to extend loans and deleveraged their risky assets. Coupled with the slowdown of the world economy, this situation led to slower growth in the volume of Thai exports. Political uncertainty also affected the confidence of foreign tourists, resulting in a decrease in exports of services in this quarter, affecting the expansion of the Thai economy. The overall economy in 2008 Q3 was expected to grow by less than forecasted by the MPC in the previous Report, and at a lower rate compared to 2008 Q2. Going forward, softer oil prices, a rise in farm incomes, and accommodative monetary policy would be positive factors supporting economic expansion. However, with the momentum of growth from 2008 Q2 and a more moderate economic expansion expected in 2008 Q3, together with increasing risks from the world economy, the Thai economy was expected to expand by less than earlier projections. During the second half of 2008 up until the first half of 2009, the Thai economy would slow down from the first half of 2008. Concerns over political uncertainty led consumers to postpone part of their consumption, particularly durable goods. Additionally, some public investment projects were likely to be delayed, in turn resulting in a slowdown in private investment. Export of goods was likely to moderate somewhat in tandem with the slowdown of the world economy. At the same time, exports of services - particularly tourism - was expected to register a lower growth rate as a result of the slump in the world economy, which affected the ability to spend of foreign tourists, and uncertainty in the domestic political situation which affected the confidence of foreign tourists and would take some time to recover. In the second half of 2009, the Thai economy would begin to recover in line with improved conditions in the world economy, while domestic negative factors were expected to have dissipated. Government investments in large-scale projects were expected to materialize during this period, and would help support economic expansion both directly and indirectly. In particular, improved business sentiment, coupled with the continued high level of capital utilization in the industrial sector, would lead to a rapid recovery in private investment. However, both investment and exports are still dependent on imports of capital goods and raw materials. Therefore, any acceleration in investment and exports would be followed by an acceleration in imports during the
Bank of Thailand
second half of the year. The current account was therefore expected to adjust slightly from a small surplus in 2008 to a close-to-balance level in 2009. This is in line with the current account level projected by the MPC in the last Report. Given the aforementioned economic conditions and trends, the MPC adjusted the forecast range for economic growth over the upcoming 8 quarters down slightly to between 4.3-5.0 per cent in 2008 and between 3.8-5.0 per cent in 2009, lower than the forecast in the previous Report. The fan chart is skewed downwards in both years, reflecting the downside risks which outweighed the upside risks. The most important downside risk stemmed from the possibility that the world economy could enter a peried of deep recession as a result of an extended global financial crisis. In addition, the slightly wider fan chart reflected remaining uncertainties, which the MPC deemed to have increased compared to the previous projection. Notwithstanding the fact that the stability of the Thai economy remained at a satisfactory level, as reflected in improved profitability of the business sector, the ability of the household sector to service debts, and the decline in the ratio of non-performing loans (NPLs) of financial institutions, risks to economic stability going forward increased from the previous assessment. The lower cost of living and production costs of business as a result of a lower oil prices would not offset the increased risks to both the domestic economy and the global financial system. This, together with fragile domestic demand, would adversely affect important sectors in the economy. Liquidity in the banking sector could tighten, should the business sector turn to domestic sources to raise funds as costs of borrowing abroad increased. The MPC therefore deemed that it would be necessary to monitor these risks closely.
Inflationary outlook and monetary policy

Price pressures began to moderate in 2008 Q3 following a downward trend of world oil prices and the prices of important agricultural goods such as rice. In addition, consumers concerns over inflation declined as a result of the governments temporary measures to alleviate the publics cost-of-living burden through the exemption of certain utility charges and fees for certain types of public transport.
However, the pass-through to the prices of other goods and services was likely to continue. In addition, costs of production remained elevated, as reflected in the accelerated year-on-year rise in the consumer price index compared to the last quarter. In addition, the price adjustment of some goods was still restricted under the Ministry of Commerces price administration measures. Overall, these signs pointed towards the fact that price pressures still remained.
Chart 1.1 Consumer price index
Core inflation target range Annual percentage change 10 9 Sep 8 7 Headline inflation 6.0 6 5 4 3.5 3 2.6 2 Core inflation1/ 1 0 0 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2006 2007 2008 2005
Note: 1/Consumer price index excluding raw food and energy items Source: Trade and Economic Index Bureau, Ministry of Commerce
Going forward, the MPC assessed that price pressures were lower than anticipated in the previous Report. This was due to a decline in price pressures in 2008 Q3 as mentioned earlier, as well as the softer trend of world oil prices and prices of other raw materials. Moreover, softer economic growth made it more difficult to pass on costs by raising the prices of goods and services in the consumer basket. In addition, lower inflation expectations would help reduce the pressure for higher wage bargaining. Overall, both headline and core inflation were expected to trend downwards for the rest of 2008. In 2009, the end of the governments 6 measures to alleviate the publics cost of living would lead to only a slight acceleration of core and headline inflation, given the expected downward trend of oil prices compared to the previous year. The lower-than-expected economic expansion would also reduce pressures from the demand side somewhat. However, as the economy began to recover during the latter part of
Bank of Thailand
2009, headline and core inflation would trend upwards following rising pressure from demand side, but would still remain lower than that projected in the previous Report. Based on the above analysis, the MPC adjusted the inflation forecast downwards over the upcoming 8 quarters with headline inflation ranging between 6.0-6.5 per cent in 2008 and between 3.0-4.0 per cent in 2009, while the range for core inflation was projected to be between 2.0-2.5 per cent in 2008 and 2.0-3.0 in 2009. The fan chart for both core and headline inflation are skewed downwards in the first part of the forecast, reflecting downside risks of economic expansion which outweighed the upside risks. In the latter part of the forecast, the recovery of the world economy could cause the prices of oil and important commodities to rise, while at the same time the pass-through of costs would increase as the Thai economy became stronger. It is worth noting that the latter part of the fan chart of headline inflation is skewed upwards to reflect this risk while that of core inflation is more balanced.
Chart 1.2 Core inflation forecast
4 3 2 1 0 Q1 2006 Q1 2007 Q1 2008
Annual percentage change 4 3 2 1 0 Q1 2009 Q1 2010
Note: The fan chart covers 90 per cent of the probability distribution
Taking into consideration the conditions and trends of inflation as well as that of economic expansion, the MPC deemed that risks to inflation remained elevated in the beginning of 2008 Q3 due to rising oil prices and the acceleration of inflation expectations. The elevated level of inflation affected the confidence and demand of the private sector and eroded the price competitiveness of Thai exports. This in
turn would affect the Thai economys growth potential and competitiveness in the longer term. As such, the MPC deemed it necessary to adopt a tighter monetary policy stance to maintain price stability and to ensure economic growth in the long run. The MPC therefore decided to raise the policy rate from 3.5 per cent per annum to 3.75 per cent per annum during the meeting on 27 August 2008. Towards the end of the quarter, the global financial crisis led to a clear shift in the balance of risks. The risks to growth intensified from the global economy, as well as the effect from domestic political uncertainty. At the same time, risks to inflation moderated in line with the decline in oil prices and the lower inflation expectations. In an environment of softer global and Thai economic growth, the MPC therefore decided to maintain the policy interest rate at 3.75 per cent per annum. Nonetheless, the MPC would closely monitor the risks to the world economy and would stand ready to implement appropriate monetary policy should the impact on the Thai economy worsen from the current assessment.
Bank of Thailand
Potential output and the conduct of monetary policy An important objective of monetary policy Chart 1 Output and potential output 710 is to maintain price stability so that in the long run, 700 aggregate output expands consistently with potential Positive output gap reflecting 690 output. The notion of potential output, in the broad output greater than its potential 680 sense, refers to the long-term trend component of Potential Output 670 output, after filtering out transient or irregular 660 components from the output time series. Potential 650 Output output is also referred to as the maximum 640 sustainable level of output given full utilization of 630 1993 1995 1997 1999 2001 2003 2005 2007 resources. In this sense, potential output is determined by production inputs (i.e., capital and Source: Chuenchoksan, Nakornthab, and Tanboon (2008) , Uncertainty in the Estimation of Potential Output and Implications for the Conduct labor, as well as the level of technology with which of Monetary Policy. Paper presented at the Bank of Thailand Economic Symposium, September 2008 capital and labor are used in the production process). Although an economys production can exceed the level of potential output in the short run, such overutilization will strain the economy and possibly result in major economic imbalances, such as the period leading up to the 1997 financial crisis (Chart 1). In the context of monetary policy, potential output usually refers to the level of output that an economy is able to produce without resulting in inflationary pressure. This notion of potential output is consistent with the more general notion above, albeit stated in a monetary policy context where price stability _ namely low and stable inflation _ is the focus of the analysis. That is, if actual output is in line with potential output, inflation will exhibit no tendency to rise or fall as the economy faces neither overutilization nor underutilization of resources. However, if output is above potential, resource utilization will be tight (e.g., labor would need to work overtime or machines would be required to operate over their capacity), raising the costs of production and ultimately creating inflationary pressure. Thus, the discrepancy between output and potential output, known as the output gap, is an important inflation indicator: a positive output gap usually leads to rising inflation, provided that production costs and inflation expectations remain unchanged. Consequently, an understanding and a careful assessment of potential output and the output gap play a crucial role in the monetary policy decision-making process. Estimation of potential output for the Thai economy Given that potential output is unobserved, central banks estimate potential output by relying on economic models, which are based on various assumptions, together with data, which are subject to measurement errors. In addition, judgment is required in assessing economic conditions and outlook. While estimates of potential output and the output gap are naturally surrounded by a considerable amount of uncertainty, recent findings on potential output and potential output growth for the Thai economy are summarized below.
100*ln(GDP)
Inflation Report October 2008 October 2008 Inflation Report
Table: Summary of findings on potential output estimates for the Thai economy1/ Definition of potential output Maximum sustainable level of output given full employment of available resources Trend output obtained from excluding temporary and irregular output components Level of output that the economy can produce without generating inflationary or deflationary pressures Key findings Potential output growth is projected to be in the range of 5.5-6.1 per cent over 2008-2015. Potential output growth in the previous year was estimated to be in the range of 5.2-5.3 per cent; while the output gap was estimated to be approximately zero in recent quarters.
Implications for recent monetary policy decisions The output gap at the end of 2007 and the beginning of 2008 is estimated to be close to zero (Chart 2).1/ Compared to previous quarters when the output gap was estimated to be negative, such a narrowing of the gap indicates an increase in Chart 2 Output gap estimate Per cent inflationary pressures arising from increased 0.1 resource utilization _ coupled with pressures from 0.0 Method 1 (Hodrick-Prescott filter) higher production costs and rising inflation -0.1 Method 2 (Unobserved component model) expectations2/. This resulted in an acceleration in -0.2 -0.3 inflation from end-2007. Moreover, as a high level -0.4 of inflation begins to adversely affect investment -0.5 decisions, which would impact potential output -0.6 going forward, monetary policy has been prudent -0.7 Q4 Q1 Q2 Q3 Q4 Q1 2006 2007 2008 with emphasis given to price stability. With regards to the output gap in 2008 Q2, the rise in the number Source: Chuenchoksan, Nakornthab, and Tanboon (2008) , Uncertainty in the Estimation of Potential Output and Implications for the Conduct of adverse risk factors to the economy are likely to of Monetary Policy. Paper presented at the Bank of Thailand Economic Symposium, September 2008 dampen economic output to below potential, to some extent. One important caveat regarding the use of output gap estimates in monetary policy formulation is uncertainty in the estimation of potential output. Model uncertainty and data uncertainty _ the latter arising from the revision of published data and the release of new data, both of which have the potential to alter previous estimates _ are inevitable. The MPC is aware of such estimation uncertainty and thus adopts various other economic indicators such as manufacturing sector resource utilization rates and the unemployment rate in the labor market, in addition to conferring with firms in a variety of industries. The MPC also carefully examines its findings and uses judgment to ensure accuracy and reliability in the measurement of inflationary pressures from resource utilization.
1/
2/
See Chuenchoksan, Nakornthab, and Tanboon (2008), Uncertainty in the Estimation of Potential Output and Implications for the Conduct of Monetary Policy. Paper presented at the Bank of Thailand Economic Symposium, September 2008. See The study of cost pass-through to prices amidst rising oil and commodity prices. Box article in Inflation Report, July 2008.
Bank of Thailand of Thailand Bank
2. Recent Developments in Inflation and Economic Conditions

Inflation trends
In 2008 Q3, global oil prices dropped from the previous quarter, with the price of Dubai oil down from an average of 116.65 US dollars per barrel in 2008 Q2 to 113.62 US dollars per barrel this quarter. The decline in oil prices resulted from the economic slowdown in the US and European countries, which reduced global demand for oil. Furthermore, Chinas demand for diesel oil also fell following the end of the 2008 Olympic Games, while alternative energy sources also became more widespread.
Chart 2.1 Dubai oil price and domestic retail oil prices A decline in global oil prices together with a cut in the excise tax on domestic retail oil prices reduced the pressure on domestic energy prices.
US dollars/barrel 160 140 120 100 Dubai oil (LHS) 80 60 40 20 Jan Jul Jan 2005 2006
Source: PTT Public Company Limited
Jul
Jan 2007
Baht/liter 6 Oct 2008 50 45 40 35 30 25 Benzene 91 (RHS) Hi-speed diesel (RHS) 20 15 10 Jul Jan Jul 2008
Pressure from global oil prices declined, while at the same time the government cut excise taxes on retail oil prices from 25 July 2008. Domestic retail oil prices, however, did not decline in tandem, given that the Energy Policy and Planning Committee increased the required contribution to the oil fund, while domestic oil retailers also took this opportunity to increase their marketing margins to compensate for negative marketing margins in the first half of this year. The increase in contribution to the oil fund and marketing margins were plausible given the decline in global oil prices such that no additional burden was placed on consumers. As a result, prices of benzene 91 and high-speed
diesel oil in this quarter were similar to those in the previous quarter, averaging at 37.85 and 36.19 baht per liter, respectively. Prices of agricultural products in 2008 Q3 increased due to unfavorable weather conditions. Furthermore, prices of other raw materials, such as those used in industrial production, continued to increase, while domestic retail oil prices remained similar to those in the previous quarter as mentioned earlier. As a result, the overall Producer Price Index (PPI) accelerated to 20.6 per cent, higher than the rates of 10.8 and 15.7 per cent encountered in 2008 Q1 and 2008 Q2, respectively.
The pass-through of production costs to prices of various goods and services continued. However, government measures together with lower-than-expected oil prices resulted in inflation rates in Q3 2008 similar to those in the previous quarter, and lower than previously anticipated by the MPC.
Even though the costs of production continued to accelerate, the Consumer Price Index (CPI) was similar to that in the previous quarter as a result of the decline in pressure from energy prices and the governments measures to alleviate the cost of living, effective from 1 August 2008 to 31 January 2009. However, the pass-through of higher energy costs in previous periods continued, notably with the increase in various public transportation fares, such as Bangkok Mass Transit Authority (BMTA) bus fares. Moreover, prices of processed food also rose. Consequently, core inflation in 2008 Q3 averaged at 2.9 per cent, similar to the previous quarter. Meanwhile, headline inflation dropped slightly from 7.5 per cent in the previous quarter to 7.3 per cent in this quarter, significantly lower than what the MPC had anticipated in the previous Inflation Report, primarily due to lower-than-expected oil prices.
Table 2.1 Quarterly inflation 2007 Unit: Per cent Percentage change from the previous year (%yoy) - Headline consumer price index Core consumer price index Raw food Energy - Producer price index Percentage change from the previous quarter (%qoq) - Headline consumer price index Core consumer price index Raw food Energy - Producer price index Q3 2007 Q4 Q1 2008 Q2 Q3
2.3 1.1 6.5 2.4 3.3 -
1.6 0.8 7.4 -1.4 1.5 0.1 0.3 0.0 -0.2 -1.8
2.9 1.1 3.2 12.7 7.0 1.5 0.5 1.8 5.7 3.9
5.0 1.5 10.3 17.2 10.8 1.6 0.5 4.2 3.8 4.1
7.5 2.8 15.5 23.0 15.7 4.2 1.6 8.0 12.4 8.9
7.3 2.9 17.5 14.9 20.6 -0.2 0.4 2.6 -6.8 2.4
Source: Trade and Economic Index Bureau, Ministry of Commerce
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Bank of Thailand
Chart 2.2 Contribution to headline inflation
Per cent 8 7 6 5 4 3 2 1 0 -1 Q1 2005
Core inflation Energy
Raw food Headline inflation
Q1 2006
Q1 2007
Q1 2008
Foreign inflation remained at an elevated level. Nonetheless, inflation trends differed from country to country depending on the speed of cost pass-through, which had increased in previous periods; the share of food and energy components in the Consumer Price Index (CPI) basket, which had changed significantly; and government measures to help reduce consumers cost of living. Overall, inflation in industrialized countries remained high due to the continued pass-through of rising energy costs in previous periods to retail prices of goods and services. In August 2008, US headline inflation stood at 5.4 per cent, close to 5.6 per cent in the previous month. Meanwhile, European HICP inflation stood at 3.8 per cent, close to the rate of 4 per cent in July, and remained consistently above the ECBs long-term target for price stability of 2 per cent. Nevertheless, inflation in Japan accelerated slightly from the previous month to stand at 2.3 per cent in July. Inflationary pressure in regional economies subsided due to the decline in world food and oil prices, especially in China, South Korea, Taiwan and Singapore. This was most apparent in China, where the inflation rate fell from 6.3 per cent in July to 4.9 per cent in August. Nevertheless, in some regional countries, such as Malaysia and Indonesia, inflation rates remained high following the gradual reduction in oil subsidies.
Foreign inflation rates remained high, but showed signs of slowing down following the decline in production costs, especially oil prices.
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Chart 2.3 Inflation in Thailand and Annual percentage change 10 10 8 8 Sep Thailand 6 6.0 6 4 Jul 2 4 5.7 2 0 Trading partners (22) 0 -2 2005 2006 2007 2008 2005 20 Aug 6 12.5 15 11.9 4 10 8.5 Philippines Indonesia 2 5 Malaysia 6.4 0 0 Singapore -5 -2 2005 2008 2005 2006 2007
Source: Various official sources and Bloomberg
other countries
Aug 5.6 4.9 4.8
China South Korea Taiwan 2006 US EU-15 Japan 2006 2007 2008 2007
2008 Aug 5.4 Aug 3.8 Jul 2.3
Aggregate demand in 2008 Q2

In 2008 Q2, the Thai economy grew by 5.3 per cent year-on-year
1/
The Thai economy grew by 5.3 per cent year-on-year in 2008 Q2, displaying a slowdown from the growth rate of 6.1 per cent in the first quarter. The slowdown was due mainly to the deceleration in private expenditure - both in consumption and investment - coupled with a decline in real government expenditure. Nevertheless, exports continued to expand well, and as a result, net exports reemerged as the main driver of economic growth as the growth momentum from domestic demand faded. The overall contribution to GDP growth from net exports, domestic consumption, and overall investment were 2.6 per cent, 1.1 per cent, and 0.4 per cent, respectively. On a seasonally-adjusted basis, the Thai economy displayed twoconsecutive quarters of deceleration. The economy grew by 0.7 per cent quarter-on-quarter in 2008 Q2, compared to 1.3 per cent in 2008 Q1 and 1.7 per cent in the quarter before. Such a slowdown caused the growth momentum of the Thai economy to be lower than that assessed by the MPC in the previous Report.
1/
Data used to analyze aggregate demand in 2008 Q2 was obtained from the NESDB. Economic indicators used for analyzing 2008 Q2 and the outlook for 2008 Q3 were obtained from the BOT, except for the Consumer Confidence Index, which was produced by the University of the Thai Chamber of Commerce, and data on government expenditure, which originated from the Comptroller Generals Department and was compiled by the Fiscal Policy Office.
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Bank of Thailand
Chart 2.4 Real GDP growth at 1988 prices
Per cent 8 2005 = 4.5 6
2006 = 5.1
2007 = 4.8 5.3
Growth rate (%yoy) 4 2 0.7 0 -2 Growth rate (%qoq) (seasonally adjusted) Q1 2005 Q1 2006 Q1 2007 Q1 2008
Source: National Economic and Social Development Board
Chart 2.5 Contribution to GDP growth
Per cent 14 12 10 8 6 4 2 0 -2 -4 -6 -8 Q1 2005
Private consumption Private investment Net exports of goods and services GDP
Public consumption Public investment Changes in inventory and statistical discrepancies
Q1 2006
Q1 2007
Q1 2008
A closer inspection of aggregate demand components in 2008 Q2 showed private consumption growth of 2.4 per cent from the same period last year, down from 2.6 per cent in the previous quarter. The slowdown resulted mainly from the decline in consumption of non-durable goods, while the growth in consumption of durable goods remained close to the previous quarter. This was partly due to a rise in the purchase of motorcycles and alternative energy (E20) compatible cars amid rising oil prices. In addition, the government had promoted
The slowdown in domestic demand following the decline in growth in private investment and government expenditure contributed to lower economic expansion than in the previous quarter.
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the use of energy saving cars by lowering excise taxes since the beginning of 2008. All in all, the contribution to GDP growth from private consumption remained close to the previous quarter, standing at 1.3 per cent.
Chart 2.6 Contribution to PCE growth
Per cent 6 4 2 0 -2 Q1 2005 Q1 2006 Q1 2007
Services Non-durables Semi-durables Durables PCE
Q1 2008
Private investment this quarter expanded by 4.3 per cent year-on-year, slowing down from 6.5 per cent in the previous quarter, due to decelerating machinery and equipment investment. This slowdown was in line with the decline in the Business Sentiment Index (BSI) which fell from 45.9 in the previous quarter to 42.6 this quarter. Nevertheless,
Chart 2.7 Contribution to private investment growth
Per cent 15 10 5 0 -5 Q1 2005 Q1 2006
Private investment : machinery and equipment Private investment : construction Private investment
Q1 2007
Q1 2008
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Bank of Thailand
investment in construction continued to improve, particularly for housing and commercial buildings such as condominiums in Bangkok and the surrounding vicinity. On the fiscal side, the disbursement rate in the third quarter of fiscal year 2008 registered at 24.5 per cent of the entire annual budget, which was lower than the same period last year. However, this was due to an unusually high disbursement in the corresponding period in the previous year, following a delay in the approval of the 2007 Budget Act. Moreover, high inflation partly weakened the real effect of fiscal stimulus. Overall, real public consumption expenditure contracted by 2.4 per cent year-on-year, while public investment shrunk by 5.2 per cent, following a decline in construction activities of both the central and local government. As a result, the contribution of public spending to GDP growth in the second quarter remained limited. On the external front, net exports in 2008 Q2 emerged once again as the main economic growth engine after some moderation in the previous quarter, given the rise in exports coupled with the fall in imports. The volume of exports of goods and services accelerated from 8.7 per cent in the previous quarter to 9.3 per cent. Export goods that showed robust expansion included computers and computer parts, petrochemical products, plastic, chemical products, vehicle parts, jewelry and accessories, as well as agricultural products, particularly rice and cassava. The volume of imports of goods and services decelerated from 10.1 per cent in the previous quarter to 6.9 per cent, following a slowdown in imports of fuel, capital goods, and consumer goods due to weakening domestic demand and a decline in oil consumption, in response to rising oil prices in recent periods.
Net exports continued to play a significant role as an economic growth engine.
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Trend of aggregate demand in 2008 Q3

In 2008 Q3, political atmosphere the dampened confidence, causing private expenditure, especially investment, to expand only slightly.
In July and August 2008, private consumption and private investment indicators compiled by the Bank of Thailand pointed towards continued growth in private expenditure, but the overall trend remained subdued. The Private Consumption Index (PCI) averaged at 143.9, edging up from the average of 139.8 in the second quarter from growth in consumption of both durable and non-durable goods, especially from sales growth of passenger cars, stimulated by lower excise taxes for alternative energy (E20) compatible cars. Moreover, motorcycle sales expanded as farm incomes rose in response to rising agricultural prices in the past period. Despite the governments economic stimulus measures and cost of living relief packages, political turmoil continued to weaken consumer confidence, as reflected in the 2-month average Consumer Confidence Index (CCI) which stood at 78.3, close to 78.9 in the previous quarter.
Chart 2.8 Consumer confidence index and private consumption growth
Index 100 Private consumption growth (RHS)
Annual percentage change 6 Consumer confidence index
80 2.4
77.7 4
60
40 Q1 2005 Q1 2006 Q1 2007 Q1 2008
Jul Aug
Source: The University of the Thai Chamber of Commerce and National Economic and Social Development Board
In September, rising uncertainty in the political arena was likely to dampen consumer confidence. Although the rise in the Private Consumption Index in the first two months of the quarter was higher than in the previous quarter, the MPC assessed that consumption growth in September was likely to be muted. As a result, overall private consumption in the third quarter was likely to remain steady or slightly higher than in the second quarter.
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Bank of Thailand
The Private Investment Index (PII) in July and August 2008 averaged at 177.3, edging up from 175.3 in the second quarter. Investment in machinery and equipment expanded at a similar rate as the previous quarter, following a rise in imports of capital goods, especially electric machinery and machinery for manufacturing. Meanwhile, commercial car sales declined and construction investment turned sluggish, as reflected in the decline in permitted construction area and domestic cement sales. A softer momentum in private investment stemmed partly from a decline in business confidence. The Business Sentiment Index (BSI) for the first 2 months of this quarter averaged at 41.1, a decline from 45.0 and 42.2 in the first and the second quarters of 2008, respectively. The fall in business confidence resulted mainly from concerns regarding political stability which negatively affected the investment climate, leading to postponement of many investment projects, despite a reduction in production costs.
Chart 2.9 Business sentiment index and private investment growth
Index 50 Private investment growth (RHS) 45
Annual percentage change 15 Business sentiment index 10 40.7 5 4.3 0 -5
40 35 30 Q1 2005 Q1 2006 Q1 2007 Q1 2008
Jul Aug
Source: Bank of Thailand and National Economic and Social Development Board
On the fiscal side, government revenue collection in July and August 2008 increased on average only by 0.4 per cent from the same period last year, owing largely to a decline in corporate income tax receipts as the deadline for filing semi-annual profit tax was extended from the end of August to September 1. In addition, the decline in revenue from excise taxes, particularly excise taxes on oil consumption
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as a part of the governments measures to relieve the cost-of-living burden, also contributed to the slow revenue expansion. Nevertheless, revenue from personal income tax and Valued Added Tax (VAT) collected from domestic consumption and imports continued to expand well, reflecting a rise in real economic activity as well as the effect of higher prices.
The disbursement rate of fiscal year 2008 was likely to be lower than target.
Government expenditure in July and August 2008 contracted on average by 4.8 per cent from the same period last year from both current expenditure and capital expenditure. Moreover, the overall disbursement rate of the fiscal year 2008 was likely to be lower than target. In turn, government expenditure would not be able to stimulate economic expansion at the level originally intended. This could be one of the factors that led to lower-than-expected economic growth.
Chart 2.10 Current account balance
Million US dollars 2,500 Services account 2,000 1,500 1,000 500 0 -500 -1,000 -1,500 -2,000 Jan Jul Jan 2005 2006
Source: Bank of Thailand
Trade account
Current account balance
Jul
Jan 2007
Jul
Jan 2008
Jul
Export volume slowed down, following the declining trend of the world economy.
On the external front, export volumes in July and August 2008 expanded at a slower rate compared to the previous quarter, mainly as a result of the expected slowdown of the world economy. Nevertheless, exports of manufacturing and agricultural products continued to expand well, particularly in electronic products, electrical appliances, automotive products, as well as rice and rubber. Although overall export volume growth slowed down from the previous quarter, rising prices more than compensated for the fall in volume, allowing export values in the first two month of this quarter to expand by more than the previous quarter.
18
Bank of Thailand
Both the value and volume of imports in July and August 2008 expanded at a higher rate than the previous quarter, following the acceleration of imports of raw materials, capital goods, and energy particularly LPG - due to rising domestic demand for LPG in car usage. Given the acceleration of import values, the trade balance in the first two months of the third quarter registered a deficit, compared to the surplus in the second quarter. The services account was also likely to display a deficit, following an increase in the repatriation of profits and dividends. Under these conditions, the current account this quarter was also likely to register a deficit, as previously forecasted by the MPC.
Production and supply in 2008 Q2
2/
In 2008 Q2, agricultural production expanded by more than it did the quarter before. However, the rates of growth of manufacturing production and services decelerated, causing aggregate supply to expand at a slower pace than in the first quarter. Agricultural output grew by 6.5 per cent from the same period last year, accelerating from 3.5 per cent in the previous quarter. The growth was driven mainly from expansion of rice, rubber, and palm oil production, driven in turn by the high prices of these products. In addition, the preceding period saw no flooding or natural disasters that otherwise would have affected output. Moreover, agricultural prices also increased, owing to continued domestic and global demand for energy crops, coupled with unfavorable weather conditions in major producing countries such as China, Vietnam, and India that caused scarcity of major crops supply in the world market, especially rice.
In 2008 Q2, the agricultural sector expanded well, while the manufacturing and services sectors slowed down from the first quarter.
2/
Data used to analyze production and supply in 2008 Q2 were obtained mainly from the NESDB. Economic indicators used for analyzing 2008 Q2 and the outlook for 2008 Q3 were obtained from the BOT, while data on the number of tourists and occupancy rate was in part compiled by the Tourism Authority of Thailand. Data on the labor market was obtained from the NSO.
19
Chart 2.11 Contribution to GDP growth
Per cent 8 Agriculture 6 4 2 0 -2 Q1 2005
Manufacturing
Trade
Services
Others
GDP
Q1 2006
Q1 2007
Q1 2008
Export-oriented industries continued to expand well, while overall manufacturing production slowed down slightly compared to the expansion in the first quarter.
Growth in manufacturing production remained healthy, but expanded at a slower rate compared to the first quarter. In the second quarter of 2008, production grew at 8.0 per cent compared to 9.9 per cent in the first quarter. Industries that continued to expand well included electronic and electrical appliance industries, following production expansion of hard disk drives, refrigerators, and air conditioners in response to high external demand. The automotive industry also expanded well from the production of alternative energy (E20) and NGV compatible cars, as they became more popular in the midst of rising oil prices and government tax reductions to support such energy saving cars. The motorcycle industry expanded in response to a higher demand from consumers in rural areas, following the rise in farm income. Moreover, the food industry showed a healthy expansion, particularly in the sugar and canned seafood export industries. Growth in the services sector slowed down from 4.4 per cent in the first quarter to 3.6 per cent this quarter, as a result of the slowdown in air transport services due to higher oil prices. In addition, financial service activities also decelerated, following a decline in commercial banks income. However, hotel services continued to grow in tandem with the revival of number of tourists from neighboring countries as well as East Asia as a result of governments promotional campaigns and the decline of air pollution problems in the North.
20
Bank of Thailand
The unemployment rate continued to remain at a low level, registering at 1.2 per cent at the end 2008 Q2, falling from 1.5 per cent at the end of 2008 Q1. This was in line with the overall employment rate which grew at 1.9 per cent from the same period last year, following an increase in employment in the agricultural and services sectors. Meanwhile, employment in the manufacturing sector declined, partly because of labor mobility from the manufacturing to the agricultural sector in favor of higher agricultural prices.
The unemployment rate remained low at 1.2 per cent at the end of 2008 Q2.
Trend in production and supply in 2008 Q3

During July and August 2008, crop production grew sharply on average by 20.6 per cent from the same period last year, mainly from growth in output of palm oil, rice, and rubber. High prices of major crops encouraged farmers to expand their production. Meanwhile, planting conditions were favorable, contributing to a good harvest. During these 2 months, prices of major crops rose on average at 39.2 per cent from the same period last year, a marked increase from 23.9 per cent in the last quarter. Coupled with robust output expansion, farm income was expected to rise more rapidly than in previous quarters. This would help support private consumption, particularly in rural areas. However, the rise in crop prices was expected to begin to slow down in the following period. The supply of rice in the world market was expected to expand, particularly from major producers such as Vietnam and India. Moreover, several countries had abrogated their rice export restraints and commodity speculation had also subsided. Manufacturing production in 2008 Q3 began to show signs of slowing down. This was reflected in the Manufacturing Production Index (MPI) in July and August 2008, which expanded at a slower rate than the previous quarter, following a slowdown in domestic oriented industries. This was in tandem with the subdued domestic demand. Meanwhile, production of export-oriented industries continued expand on the back of production of hard disk drives. Nevertheless, the MPC viewed that this industry could slow down in the upcoming period once the world economic downturn became more apparent.
Export-oriented industries continued to expand well, while domestic-oriented industries slowed down from the previous quarter. In 2008 Q3, farm income continued on a rising trend, helping to stinulate consumption in rural areas.
21
Chart 2.12 Contribution to manufacturing production index (MPI) growth
Per cent 16 14 12 10 8 6 4 2 0 -2 Q1 2005

Export-oriented industries (export>60%) Both domestic and export industries (export 30%-60%) Domestic-oriented industries (export<30%) MPI growth
Jul Aug Q1 2006 Q1 2007 Q1 2008
The tourism industry slowed down due to various factors.
Tourism in 2008 Q3 slowed down significantly for several reasons. Rising oil prices caused airlines to increase their fuel surcharges and reduce the number of flights. In addition, increasingly widespread domestic political unrest towards the end of August dampened confidence among foreign tourists. Finally, the economic slowdown in the home countries of foreign tourists became more apparent. As a result, the number of tourists increased on average by only 4.8 per cent during the first two months of the quarter, a significant slowdown from the growth
Chart 2.13 Number of tourists
Thousand persons 1,700 1,500 1,300 1,100 900 700 500
2006
2007
2008
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Source: Tourism Authority of Thailand and Bank of Thailand
22
Bank of Thailand
Chart 2.14 Hotel occupancy rate
Per cent 75 2006 70 65 60 55 50 45 40 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Source: Tourism Authority of Thailand and Bank of Thailand
2007
2008
of 15 per cent in the previous quarter. Moreover, the occupancy rate also declined from the same period last year, as the tourist numbers increased at a slower rate than the increase in the number of hotel rooms. Despite a slowdown in production in some industries, the unemployment rate remained low at 1.2 per cent. In addition, the latest labor market figure in August 2008 revealed employment growth of 1.3 per cent from the same period last year.
Chart 2.15 Employment growth and sectoral contributions The unemployment rate continued to remain low.
Per cent 5 Agriculture 4 3 2 1 0 -1 -2 -3 Q1 2005

Source: National Statistical Office
Manufacturing
Trade
Services
Others
Overall
Jul Aug Q1 2006 Q1 2007 Q1 2008
23
3. Monetary Conditions in the Last 3 Months

Following the release of the previous Inflation Report in July 2008, the MPC meeting on 27 August 2008 assessed that although the Thai economy slowed down in the second quarter, risks to inflation deserved crucial consideration. Even though the decline in oil prices and the effect of the governments measures to alleviate the cost of living would reduce inflationary pressures in the immediate future, both inflation and inflation expectations remained elevated. In addition, as oil prices were expected to remain uncertain in the periods ahead and could potentially adjust upwards, the MPC decided to raise the policy interest rate by 0.25 per cent, from 3.50 per cent to 3.75 per cent per annum in light of these inflationary risks. Moreover, the MPC deemed that monetary policy conditions following the policy interest rate adjustment remained accomodative and would continue to support economic growth. In the meeting on 8 October 2008, the MPC assessed that there was a clear shift in the balance of risks towards growth. The risks to growth intensified from the impact of the global financial crisis as well as increasing domestic political uncertainty. At the same time, risks to inflation moderated in line with the decline in oil prices, and despite remaining pressures from the gradual adjustment of administered prices. The MPC therefore decided to maintain the policy interest rate at 3.75 per cent per annum. Nonetheless, the MPC would closely monitor the risks to the world economy and would stand ready to implement appropriate monetary policy should the impact on the Thai economy worsen from the current assessment.
Money market conditions

In 2008 Q3, short-term money market interest rates rose in line with the policy interest rate. However, the 1-day repurchase rate and the overnight interbank rate averaged at 3.56 and 3.54 per cent per annum in 2008 Q3, an increase from the 2008 Q2 average of 3.25 and 3.21 per cent per annum respectively. However, the fact that both interest rates moved in tandem with the policy rate reflected the fact that there was no significant impact on Thai baht liquidity, despite problems in foreign financial institutions which occurred towards the end of this quarter.
Short-term money market rates rose in line with the policy interest rate.
25
Chart 3.1 Money market interest rates
Per cent per annum 6.5 14-day repurchase rate 6.0 5.5 Overnight swap rate (onshore) 5.0 4.5 1-day repurchase rate 4.0 interbank 3.5 Overnight(mode) rate 3.0 3-month T-bill rate 2.5 2.0 1.5 1.0 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2006 2007 2008
7 Oct 3.75 3.75 3.70 3.55 2.98
Oct
The overnight swap rate averaged at 3.24 per cent per annum, an increase from the previous-quarter average of 2.97 per cent per annum. However, the volatility of the overnight swap rate at the end of September increased relatively to the previous quarter due to the decline in US dollar liquidity in the domestic money market. The tightening of liquidity was triggered by the more apparent sign of a slowdown of the US economy, particularly following the US Congresss failure on its first attempt to pass the financial sector relief bill on 29 September 2008. Meanwhile, there was ample Thai baht liquidity in the local money markets.
The yields on long-term government bonds declined in line with inflation expectations.
Yields on government bonds in 2008 Q3 flattened compared to 2008 Q2. Yields on bonds with less than one year maturity rose in line with the policy interest rate. In contrast, yields on bonds with more than one year maturity declined in line with falling inflation expectations as a result of a decline in world oil prices, as well as increased domestic political uncertainty which drove investors to diversify their investments away from the stock market to the bond market. As a result, the spread of 10-year and 2-year bonds narrowed from 1.17 per cent per annum at the end of 2008 Q2 to 0.55 per cent per annum at the end of 2008 Q3.
26
Bank of Thailand
Chart 3.2 Government bond yields Per cent per annum 6.5 30 Jun 08 31 Jul 08 6.0 29 Aug 08 7 Oct 08 5.5 5.0 4.5 4.0 3.5 3.0 3 months 1 2 3 5 7 10
Per cent per annum 0.2 0.1 0 -0.1 -0.2 -0.3 3 months 1
12 14 Maturity (years)
Changes in government bond yields

(end-2008 Q3 compared with end-2008 Q2)
10
12 14 Maturity (years)
Chart 3.3 Government bond yield spread between 10-year and 2-year bonds
Per cent per annum 7 6 5 4 3 2 1 0 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct 2005 2006 2007 2008
10Y 2Y
7 Oct 4.45 3.64
Spread
0.81
The slope of the implied forward curve, reflecting market expectations of short-term interest rates in the future, was relatively flat. However, the short-term interest rate ten years from now continued to decline from the end of the previous quarter, in line with the fall in investors inflation expectations. In addition, the decline of the short-term interest rate, 1-2 years from now, indicated market expectations that the MPC would not raise the policy interest rate any further due to a decrease in inflationary pressure.
27
Chart 3.4 Government bond implied forward curves
Per cent per annum 7 6 31 Jul 08 5 4 1 Apr 08 3 2 0 1 2 3 4 5 6 7 8 9 10 29 Aug 08
30 Jun 08 7 Oct 08
11 12 13 14 15 Year(s) from now
Monetary base and money supply

The monetary base accelerated while broad money continued to slow down.
In July and August 2008, the monetary base expanded from the same period last year by an average of 9.5 per cent. The monetary base and currency in circulation continued to exhibit an increasing trend since early 2007, reflecting recent economic expansion and the rise in the price level in previous periods. Broad money in July and August 2008 contracted from the same period last year at an average rate of 0.2 per cent, the first contraction since the economic crisis in 1997. This slowdown resulted from a shift
Chart 3.5 Growth rate of money supply
Annual percentage change 20 15 Monetary base 10 5 0 -5 Jan Jan 2006 2005 Annual percentage change 15 Broad Money 10 5 0 -5 Jan Jan 2005 2006
Currency in circulation
Aug 11.6 10.5
Jan 2007
Jan 2008 Narrow Money Aug 9.7 0.7
Jan 2007
Jan 2008
28
Bank of Thailand
Chart 3.6 Contribution to Broad Money growth

Securities other than shares Other deposits at specialized banks Deposits at finance companies Other deposits at commercial banks Demand deposits at Other Depository Corporations Currency in circulation Broad Money growth
Per cent
14 12 10 8 6 4 2 0 -2 -4
Aug 0.7
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2005 2006 2007 2008
in savings away from commercial bank deposits, which typically are a major component in broad money, to assets with more attractive returns such as bills of exchange. As bills of exchange are not included in the definition of money supply or commercial banks deposits, broad money under the current definition registered an expansion at a lower-thanactual rate.
Adjustments of the banking system

The MPC decided to raise the policy interest rate twice in 2008 Q3 from 3.25 per cent per annum to 3.75 per cent per annum. However, commercial banks had not adjusted their reference deposit rate and MLR since the last adjustment in June 2008, in which commercial banks raised their reference interest rates ahead of the MPCs decision. As a result, the 3-month and 12-month time deposit rates of the four largest commercial banks at the end of 2008 Q3 averaged at 2.37 and 2.75 per cent per annum, respectively, unchanged from the end of the previous quarter. The average MLR of the four largest commercial banks also remained unchanged at 7.25 per cent per annum at the end of 2008 Q3. In spite of unchanged reference rates, however, commercial banks continually launched special deposit products to attract deposits to support their liquidity management, in an environment of sluggish deposit growth and gradually tightening liquidity in the banking sector.
-
29
Table 3.1 The policy rate and banks reference retail rates* 2006 Unit: Per cent per annum Dec Policy rate Average reference retail rates of the 4 largest banks Savings 3-month 6-month 12-month 24-month MLR
Note: *Rates at end-period Source: Bank of Thailand
2007 Mar 4.50 Jun 3.50 Sep 3.25 Dec 3.25 Jul 3.50
2008 Aug 3.75 Sep 3.75
5.00
0.75 3.44 3.69 4.00 4.69 7.69
0.75 3.25 3.25 3.25 3.69 7.50
0.75 2.25 2.25 2.25 2.50 7.00
0.75 2.06 2.06 2.31 2.50 6.87
0.75 2.06 2.06 2.31 2.50 6.87
0.75 2.37 2.50 2.75 3.50 7.25
0.75 2.37 2.50 2.75 3.50 7.25
0.75 2.37 2.50 2.75 3.50 7.25
Chart 3.7 Policy rate and commercial banks reference retail rates*
Per cent per annum 8 7 6 5 4 3 2 6-month 1 0 Jan Apr Jul Oct Jan Apr Jul 2005 2006
MLR
Sep 7.25
Policy rate 12-month 3-month 3.75 2.75 2.50 2.37
Oct Jan Apr Jul Oct Jan Apr Jul 2007 2008
Note: *Average rate of the 4 largest commercial banks at end-period Source: Bank of Thailand
Real interest rates began to rise as inflation slowed down.
Real interest rates began to rise as inflation slowed down, in line with the decline in oil prices and the implementation of the governments measures to alleviate the publics cost-of-living burden at the end of July 2008. The real MLR1/, therefore, returned to positive territory, registering at 1.20 per cent per annum at the end of September 2008. The real 12-month deposit rate2/ also adjusted upwards but
1/
2/
Real MLR = MLR - contemporaneous headline inflation Real 12-month deposit rate = 12-month deposit rate - average forecasted inflation 12 months ahead
30
Bank of Thailand
remained negative, registering at -1.30 per cent per annum at the end of September 2008.
Chart 3.8 Commercial banks interest rates*
Per cent per annum Sep 8 MLR 7.25 6 Real MLR 12-month time deposit rate 4 2.75 2 1.20 0 -1.30 -2 Real 12-month time deposit rate -4 -6 -8 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2005 2006 2007 2008
Note: *Average rate of the 4 largest commercial banks Source: Bank of Thailand
Deposits of Other Depository Corporations3/ in August 2008 expanded slightly at the rate of 0.3 per cent from the same period last year. Deposit growth exhibited a declining trend since the middle of 2006, as a result of household and corporate sectors reallocating their deposits to investments which yielded higher returns, including government bonds and mutual funds. This was particularly apparent in a relatively high inflation environment where bond yields increased rapidly in line with higher inflation expectations, while the return on bank deposits showed little change. Moreover, the irregular slowdown in the growth of bank deposits resulted partly from a switching of commercial bank funding from its traditional deposit base to funding through bills of exchange.
Deposit growth slowed down since the middle of 2006.
3/
Other Depository Corporations comprise of domestically registered commercial banks, branches of foreign bank, international banking facilities, finance companies, Specialised Financial Institutions (including Government Savings Bank, Government Housing Banks, Bank for Agriculture and Agricultural Cooperatives, Export-Import Bank of Thailand, Small and Medium Enterprise Development Bank of Thailand, Islamic Bank of Thailand), saving cooperatives, and money market mutual funds.
31
Chart 3.9 Other Depository Corporations deposits and private credits
Annual percentage change 12 10 8 6 4 2 0 -2 Jan 2006 Apr Jul Oct Jan 2007 Apr Jul Oct Jan 2008 Apr Jul Private credits Deposits Private credits*
Aug 11.9 11.3
0.3
Note: *Excluding the effects of loan write-offs and transfers to AMCs Source: Bank of Thailand
Chart 3.10 Contribution to growth of deposits of Other Depository Corporations
Per cent 12 10 8 6 4 2 0 -2 Jan Apr 2006

Others Deposits of other financial institutions Deposits of the household sector Deposits of the business sector Growth of deposits
Aug 0.3 Jul Oct Jan Apr 2007 Jul Oct Jan Apr 2008 Jul
Private credits accelerated as a result of an increase in demand for loan under high inflationary pressure.
In July and August 2008, private credits of depository institutions expanded from the same period last year by 10.3 and 11.3 per cent respectively, a continued expansion since the end of 2007, mainly as a result of the expansion of corporate sector credits. This was partly due to the continued low-interest-rate environment, as well as the need for more working capital and investment funds given the rise in raw material costs. Removing this effect by deflating the expansion of credits for
32
Bank of Thailand
Chart 3.11 The spread of 12-month deposit rate and 1-year government bond yield, and the growth of Other Depository Corporations deposits
Annual percentage change Per cent 8 -0.2 12-month deposit rate and 1-year government bond yield spread (RHS) 6 -0.4 Deposits 4 -0.6 Aug 2 0.34 -0.8 -0.97 0 -1.0 -2 The loosening of monetary policy -1.2 -4 -1.4 Jan Apr Jul Oct Jan Apr Jul 2007 2008
working capital and investment by the rates of change of the Producer Price Index and Private Investment Deflator, respectively, showed little real corporate sector credit growth from the end of the previous quarter. This reflected the lack of any significant rise in business activities during this period.
Chart 3.12 Corporate loan growth rate of commercial banks classified by purpose
Annual percentage change 25 Investment 20 15 10 5 0 -5 -10 Real working capital -15 -20 -25 Jan Jul Jan 2005 2006
Aug Working capital
Real investment
Jul
Jan 2007
Jul
Jan 2008
Jul
33
Exchange rate and capital flows

The Thai baht continued to depreciate against the US dollar, both due to external financial and internal political factors.
The Thai baht continued to depreciate against the US dollar during the first two months of 2008 Q3, as dollar sentiment improved following the release of better-than-expected US economic figures. In addition, the prolonged political situation in Thailand affected investor confidence, as reflected in the continued sell-off of domestic equities by foreigners. These capital outflows also contributed to the weakening of the Thai baht. Nonetheless, the US dollar fell slightly against the baht in the middle of September following the bankruptcy of Lehman Brothers, a major US financial company, as well as subsequent reported losses by other major financial institutions. As a result, the Thai baht rebounded slightly for a short period until risk aversion and deleveraging by investors resulted in withdrawal of funds from emerging market economies to more secure investment alternatives such as US Treasury bills. The baht then continued to depreciate until the end of the quarter. As a result, the baht depreciated by 4.6 per cent against the US dollar in 2008 Q3, compared to the previous quarter.
Chart 3.13 Exchange rate
Baht/US dollar 45 42 39 36 33 30 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2005 2006 2007 2008
7 Oct 34.49
34
Bank of Thailand
Chart 3.14 Change in the values of foreign currencies against the US dollar (average in 2008 Q3 compared with 2008 Q2)
Australia -6.4 Philippines -5.5 -4.6 Thailand -4.2 South Korea -4.2 UK -3.9 Euro -3.8 Malaysia Japan -2.7 -2.4 Taiwan -2.2 Singapore Indonesia China -8
0.4 1.7 Per cent -2 0 2 4
-6
-4
Nevertheless, compared to regional peers, the baht depreciated against the US dollar by a lesser degree. In fact, the overall movement of the baht remained well in line with the region throughout the quarter, which was reflected in a slight decline of 2.8 per cent of the Nominal Effective Exchange Rates (NEER)4/ from the average value in the previous quarter, compared to a 4.6-per-cent depreciation against the US dollar. The Real Effective Exchange Rate (REER), calculated by deflating the NEER by relative inflation in order to reflect the countrys price competitiveness, also reported a slight decline in July and August due to the decline in the NEER as well as the overall decline in the rate of increase of prices compared to major trading partners.
Both the nominal and real effective exchange rate depreciated from the previous quarter.
4/
The Thai baht NEER is calculated as a weighted average of bilateral exchange rates between the baht and major trading partners currencies.
35
Chart 3.15 Nominal effective exchange rate of the Thai baht (NEER) (Trade-weighted, 1994 = 100)
Index 95 90 85 80 75 NEER 70 65 Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul 2002 2003 2004 2005 2006 2007 2008
Aug 89.15 REER
Sep 76.79
The differential between the Thai and the US policy rates at the end of 2008 Q3 widened.
During 2008 Q3, two policy rate hikes and the unchanged Fed funds rate from the previous quarter resulted in a widening in the differential between the Thai and US policy rates to 1.75 per cent at the end of this quarter. Nonetheless, the widening interest rate gap did not cause a significant impact on international capital flows, which during recent periods have been more sensitive to the current political pressures and concerns over the ongoing US financial crisis.
Chart 3.16 LIBOR, Fed funds rate and Thai repurchase rate
Per cent per annum 6 7-day LIBOR 7 Oct 5 4.19 1-day repurchase rate 4 3.75 3 Fed funds 2.00 2 1.75 1 0 -1 Interest rate differential between -2 1-day repurchase rate and Fed funds rate -3 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct 2005 2006 2007 2008
36
Bank of Thailand
Overall external stability remained sound in spite of the current account deficit during the first two months of the quarter, which resulted from an acceleration in the value of imports. In conjunction with continued outflows of foreign capital from the stock market due to growing concerns about the US crisis and prolonged domestic political turmoil, the balance of payments registered a continued deficit from the last quarter. International reserves, inclusive of the BOTs net forward position, declined from 124.1 billion US dollars at the end of Q2 2008 to 117.1 billion US dollars at the end of August 2008. External liquidity indicators remained satisfactory, with the ratio of international reserves to short-term external debt registering at 4.1 times at the end of July.
Table 3.2 Balance of payments Unit: Billion US dollars Current account balance* Net capital flows* Bank of Thailand Public Bank Others Balance of payments 2007 14.0 -2.4 -0.6 -2.2 -1.1 1.6 17.1 2007 H1 5.1 -1.6 -0.8 -1.8 -6.7 7.6 5.7 H2 9.0 -0.8 0.1 -0.4 5.5 -6.1 11.4 Q1 2.7 13.4 0.6 0.4 6.9 5.4 18.5 Q2 -1.0 -2.1 -0.4 -0.2 0.1 -1.6 -2.5 2008P Jul -0.9 -1.3 0.1 0.0 -0.3 -1.1 -0.7 Aug E -0.9 0.1 -0.1 -0.2 0.9 -0.5 -0.8 Jan-AugE -0.1 10.1 0.2 0.1 7.5 2.3 14.5
Overall external stability remained favorable.
Note: * Reinvested earnings are recorded as part of direct investment in the financial account, and its contra entry recorded as investment income in the current account P = Preliminary E = Estimated data and will be adjusted except the current account balance. Source: Bank of Thailand
37
4. Financial Stability Conditions and Outlook

In 2008 Q2, risks to Thailands financial stability increased from the acceleration in inflation and the slowdown in domestic demand. The latter was partly due to the increase in political uncertainty. However, the economic sectors were able to withstand these risks. As a result, overall financial stability remained sound as reflected by firms profitability and households ability to service debt, which remained satisfactory. Furthermore, the ratio of non-performing loans (NPLs) to total loans at financial institutions declined. In 2008 Q3, the subprime problem and its impact on US financial institutions amplified, causing the global financial markets to be highly volatile. In the face of these global shocks, political uncertainty in Thailand also put the Thai financial market in a more sensitive state. Consequently, the Thai financial market remained fluctuating throughout this quarter. The MPC assessed that this volatility would continue until the global financial market situation subsided. Going forward, the impact of the subprime problem on the world economy should affect Thai exports and would remain a risk factor that should be closely monitored.
Non-financial corporate sector

Data from companies listed on the Stock Exchange of Thailand (SET) in 2008 Q2 indicated that corporate sector stability remained sound despite higher production costs and the slowdown in both domestic and foreign demand, as reflected by a low probability of default (see box for further details). At the same time, operating profit margins of most firms, especially those of export-oriented businesses, increased in line with strong export conditions. As a result, businesses debt service ability improved considerably, although financial costs also increased after corporate bond interest rates had risen consistently since March. Firms financial structure remained robust, as reflected by low debt-to-equity ratio, while businesses liquidity conditions continued to be satisfactory. Although the overall business sector was able to adjust to increasing operating costs in the previous periods, some businesses in
Overall corporate sectors profitability and debt service ability improved.
39
Corporate sector vulnerability analysis from probability of default The MPC places importance on monitoring and analyzing the health of the corporate sector because the corporate sector is the major production, investment, and employment unit. As the main borrower of financial institutions, it is also vital for financial stability. Should the corporate sectors ability to service debt become impaired, non-performing loans (NPLs) in the banking system could rise. Indeed, the sectors financial distress can adversely affect the banking system through the erosion of the value of collaterals held against loans as well as the value of securities held as investment by banks. In this light, corporate sector fragility is a significant source of risk to financial institutions liquidity and solvency. Moreover, problems that occur at one financial institution could grow into a systemic one, like the financial crisis that is currently playing out in the US and global markets. This article outlines how a probability of default (PD) model can help in an assessment of corporate sector stability. In general, a common method to assess corporate sector soundness relies on the use of a wide array of financial ratios. For example, operating profit margin is used to analyze corporate profitability while debt-to-equity ratio is used to measure the strength of the financial structure. However, financial ratio analysis does have its limitations, of which the inconsistency among indicators and difficulty in searching for appropriate vulnerability thresholds are a few. An alternative method is therefore created, which combines key financial ratios into a comprehensive indicator of corporate sector vulnerability - the probability of default. A probability of default can be calculated through several approaches. One of the most commonly used approaches is the random-effect probit model. In our case, data used in the model are obtained from financial statements of non-financial corporations listed on Stock Exchange of Thailand (SET) during 1994 Q1 to 2008 Q2. The model is expressed as follows.1/ y* it = a.OPMit + b.DAit + c.Kdit + d.CRit + +
it
where y*it denotes the unobserved (or latent) default status of firm i at time t and corresponds to the observed variable, yit , which equals 1 if the interest coverage ratio (ICR)2/ is less than 1 for four consecutive quarters (that is, a firm does not have sufficient income to repay interest on loans) and equals 0 in other cases; is the random-effect coefficient while the error term, it , is assumed to be distributed normally. Independent variables in the model indicate sources of vulnerability, which varies inversely with the probability of default and are represented by key financial ratios as follows: Operating profit margin (OPM)3/ reflects firms profitability and capability to service debt. Higher operating profit margin leads to higher ability to service debt, and in effect, lower probability of default.
1/
2/ 3/
The probit function can be written as Pr (yit = Xit , ) = (Xit ), where is standard normal cumulative distribution function; yit = 1 if y*it > 0 and yit = 0 if y* it < 0 ; Xit is vector of independent variables; and the coefficient vector is estimated by Maximum Likelihood Estimation (MLE). Interest coverage ratio (ICR) = Earning before interests and taxes (EBIT)/Interest expense. Operating profit margin= Operating profit / sales x 100.
40
Debt-to-asset ratio (DA)4/ reflects firms degree of leverage and sensitivity to interest rate shocks. With high leverage, firms are largely exposed to interest rate changes, which can result in lower ability to service debt and higher PD. Average cost of debt (Kd)5/ provides information about firms financing costs. If firms external funding is costly, its debt servicing ability can decline and consequently it can have a high PD. Current ratio (CR)6/ measures firms liquidity. If a firm has ample liquidity, the probability of bankruptcy should be lower. Using the model, the PD can be calculated as a marginal effect for each firm in a given period, i.e. the likelihood of a firms default given changes in the key financial ratios at any date. The median of all firms PD can give a measure of overall likelihood of corporate default. Furthermore, it is found that the calculated PD leads the NPL ratio by 3 quarters with correlation of 0.95. As a result, the PD obtained from this model can be used as a good indicator for corporate sector vulnerability as well as for risk to financial institutions.
Corporate sectors probability of default
Per cent
11 10 9 8
% total loans
50 45 40 35 30 25 20 15 10 5 0
Non-performing loans (RHS)

7 6 5
Probability of default*
4 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Note: *Median of listed companies in the Stock Exchange of Thailand (SET) Source: Stock Exchange of Thailand, calculated by Bank of Thailand
In recent years, the probability of default at the corporate-sector level in Thailand has remained at around 5 per cent, which is low compared with the levels seen pre-1997. However, PD has risen slightly since 2006 as profitability started to decline on the back of an economic slowdown and declining international competitiveness of certain export industries. Nevertheless, the corporate sectors leverage and liquidity have substantially improved, reflecting healthy financial status. Probability of default can help analyze corporate sector vulnerability. However, this analysis also has some limitations. The PD indicator calculated from the model relies on past data and therefore may not be forward-looking. In addition, the models probability of default is generated by direct credit risk and does not capture other sources of credit risks; for example, those that are market driven. In corporate sector vulnerability assessment, a more complete picture can be gleaned through the use of other indicators in conjunction with the outlined probability of default model.
4/ 5/ 6/
Debt to asset ratio = Liabilities / Assets. Average cost of debt = (D1Kd 1+D2Kd 2+...+DnKdn) / (D1+D2+...+Dn), where Dn is the debt amount from source n and Kdn is the cost of debt from source n. Current ratio = Current assets / Short-term liabilities.
Inflation Report October 2008 October 2008 Inflation Report
41
Chart 4.1 Corporate operating profit margin
Per cent 10 9 Operating profit margin of 8 domestic-oriented business* 7 6 5 Overall operating profit margin 4 3 2 Operating profit margin of 1 export-oriented business** 0 Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun 2005 2006 2007 2008
Note: * Median of domestic-oriented business (ratio of exports to total sales less than 30%)) ** Median of export-oriented businesses (ratio of exports to total sales greater than 60%) Source: Stock Exchange of Thailand, calculations by Bank of Thailand staff
Chart 4.2 Performance of listed non-financial companies

Per cent 20 15 10 5 0 -5 Jun 2005 Times 30 25 20 15 10 5 0 -5 Jun 2005
Operating profit margin
Times 2.0 1.5 1.0 0.5 0.0
Debt to equity ratio
Dec
Jun 2006
Dec
Jun 2007
Dec
Jun 2008
Interest coverage ratio
Dec
Jun 2006
Dec
Jun 2007
Dec
Jun 2008
Jun 2005 Times 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Jun 2005
Dec
Jun 2006
Dec
Jun 2007
Dec
Jun 2008
Current ratio
Dec
Jun 2006
Dec
Jun 2007
Dec
Jun 2008
Note: Each bar depicts an interquartile range, where upper and lower bounds represent the 25th and 75th percentile, respectively. The symbol + indicates the median. Source: Stock Exchange of Thailand, calculations by Bank of Thailand staff
industries such as fishery, transportation, construction and food manufacturing, had limitations in adjusting. These businesses depended highly on raw materials, namely agricultural raw materials, oil and metal, the prices of which increased significantly. As a result, production costs rose considerably, which contributed to continued increases in the delinquency rate on commercial bank loans to these businesses since 2008 Q1.
42
Bank of Thailand
Chart 4.3 Ratio of past due loans (1-3 months) of some sectors
% Total loans 6 5 4 3 2 1 0 Q1 2005

Transportation Construction
Fishery Food industry
Q1 2006
Q1 2007
Q1 2008
Going forward, operating costs should trend downwards following the decline in oil prices and the deceleration in world commodity prices. However, the global economic slowdown coupled with weak domestic demand could affect firms profitability and could render firms with already low operating profits more fragile.
Household sector
In 2008 Q2, although households cost of living increased following the acceleration in inflation, their ability to service debt
Chart 4.4 Ratio of households non-performing loans of commercial banks* (classified by purpose) Households ability to service debt remained satisfactory.
% Total loans 8 7 6 5 4 3 2 1 0 Q1 2006
Housing loans Household loans** Personal loans Credit card loans
Q1 2007
Q1 2008
Note: * Commercial banks are Thai commercial banks and foreign bank branches. ** Household loans comprise of housing loans, credit card loans, and personal loans. Source: Bank of Thailand
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Chart 4.5 Ratio of past due loans and NPLs*
Credit card loans

% Total loans 5 4 3 NPLs 2 1 0 Jun 2005 Dec Jun 2006 Dec Jun 2007 Dec "Substandard" loans (loans past due between 3 to 6 months) 2 1 Special-mention loans (loans past due between 1 to 3 months)
Personal loans under the BOT's supervision

% Total loans 5 4 3 Special-mention loans (loans past due between 1 to 3 months) "Substandard" loans (loans past due between 3 to 6 months) NPLs
0 Jun Jun 2008 2005
Dec
Jun 2006
Dec Jun 2007
Dec
Jun 2008
Note: *Bank and non-bank loans under the BOTs supervision Source: Bank of Thailand
Chart 4.6 Credit card transaction growth
Cash advance Annual percentage change 70 60 50 40 30 Bank 20 10 0 -10 Q1 2005 Q1 2006
Consumption of goods and services Annual percentage change 40 30 20 10 0 -10 Non-bank Q1 2006 Q1 2007 Q1 2008 Bank
Non-bank Q1 Q1 2007 2008
-20 Q1 2005
remained satisfactory, as reflected by the low NPL ratios for household loans. Moreover, the ratio of credit cards and personal loans past due between 1 to 3 months to total loans began to decline, partly as a result of more cautious spending of households. This was in line with the slowdown in credit card transaction growth, both for cash advances and for consumption of goods and services.
44
Bank of Thailand
Going forward, the downward pressure on inflation would help alleviate households cost of living problem. However, weak domestic demand and the global economic slowdown would affect Thailands economic growth, employment and household income, which could in turn reduce households ability to service debt.
Going forward, the fragile economy would be a risk factor to households ability to service debt.
Real estate sector

In 2008 Q2, the real estate sector as a whole improved slightly, as reflected by the rise in the number of land and building transactions following a one-year reduction in transfer and mortgage fees.
Chart 4.7 Real estate indicators The probability of a real estate price bubble remained low.
Number of land transactions

Thousand 90 Jun 85 80 75 70 65 60 Jan 2006 Jul Jan 2007 Jul Jan 2008 1,250 1,200 1,150 1,100 1,050 1,000 Jan 2006
Permitted construction areas

(Seasonally-adjusted, 12 month moving average)
1,000 square meters 1,300
Jun Jul Jan 2007 Jul Jan 2008
Source: Department of Lands and Bank of Thailand.
Chart 4.8 Construction materials price index
Annual percentage change 80 70 Overall construction materials price index 60 50 Iron and iron product price index 40 Cement price index 30 Concrete ingredient price index 20 10 0 -10 -20 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr 2006 2007 2008
Jul
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Furthermore, some home-buyers made their purchases before house prices started to climb from rising construction material prices. However, high construction material prices led to sluggish supply in the real estate sector, as reflected by the continued slowdown in permitted construction area. As such, the MPC assessed that the probability of a real estate price bubble remained low. High construction costs began to affect liquidity of some real estate firms, as seen by the slight increase in the delinquency rate from the first quarter of this year. Financial fragility had the potential to increase going forward should the economy slow down, conceivably affecting the credit quality of financial institutions, and hence should be monitored closely.
Financial institutions
Overall stability of financial institutions remained sound in 2008 Q2.
In 2008 Q2, overall stability of financial institutions remained sound. Financial institutions were able to withstand adverse shocks. Commercial banks profitability continued to be satisfactory from an
Table 4.1 Thailands Financial Soundness Indicators (June 2008)1/
2007 Key indicators (%) Mar

1. Capital adequacy 1.1 Regulatory capital to risk-weighted assets (8.50)2/ 1.2 Regulatory tier 1 capital to risk-weighted assets (4.25)2/ 2. Asset quality 2.1 Non-performing loans to total loans 3. Earning and profitability 3.1 Return on assets (ROA) 3.2 Interest margin3/ to gross income4/ 3.3 Non-interest expenses to gross income 4. Liquidity 4.1 Liquid assets5/ to total assets 4.2 Liquid assets to short-term liabilities6/ Number of banks
Note:
1/
2008 Sep Dec Mar Jun
Jun
13.93 10.93 8.49 0.20 71.7 61.4 27.1 34.4 14
13.85 11.03 8.17 1.06 71.3 56.0 27.8 34.7 14
14.63 11.66 8.58 0.29 73.0 59.3 27.1 33.9 14
14.80 11.86 7.86 0.12 75.1 60.7 24.7 31.9 14
14.49 11.52 7.35 1.30 71.3 50.5 20.3 25.7 14
15.02 11.51 7.01 1.18 72.2 52.2 20.4 27.4 14
Based on Peer Group data 2/ Minimum regulatory capital to risk-weighted assets 3/ Interest margin = Interest income and dividend - Interest expenses 4/ Gross income = Interest margin + Non-interest income 5/ Liquid assets = Cash and deposits + Securities purchased under resale agreements + Investment in securities (net) 6/ Short-term liabilities = Deposits (Liability side) Source: Bank of Thailand
46
Bank of Thailand
Chart 4.9 Performance of Thai commercial banks*
Billion baht 60 40 20 0 -20 -40 -60 Q1 2005
Income tax expenses Bad debt and doubtful accounts and loss from debt restructuring Profit from ordinary activities Net profit
Q1 2006
Q1 2007
Q1 2008
Note: *Based on data of 18 Thai commercial banks Source: Bank of Thailand
increase in interest income following credit expansion. Nevertheless, operating profits declined slightly due to realized loss from investments in US subprime-related securities. In any event, the capital adequacy ratio remained high while the NPL ratio continued to decline. The acceleration in credit expansion combined with low deposit growth led to a decline in liquidity in the Thai commercial banking system. However, most commercial banks increased their liquidity by issuing other financial papers, such as bills of exchange. Going forward, the MPC assessed that Thai commercial banks would be affected to a degree by the US financial crisis. The line of reasoning was based on the fact that even though investments in foreign assets represented only 1.3 per cent of Thai commercial banks total assets and only a small part of those assets were marked-down securities, tight liquidity conditions in many developed financial markets, including the US, coupled with the increase in investors risk aversion, could result in more capital outflows from regional emerging markets in favor of low-risk assets in developed countries. Liquidity in the Thai financial market and at commercial banks could tighten somewhat going forward. Furthermore, the global economic slowdown together with weak domestic demand could lead to an increase in the NPL ratio.
The subprime problem in the US could affect Thailands financial institutions liquidity and credit quality going forward.
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Financial markets
In the second and the third quarters of 2008, the Thai financial market remained volatile in line with the global financial markets, as financial distress affected the conditions of many US and European financial institutions. Furthermore, political uncertainty in Thailand was a factor that caused the Thai financial market to gyrate more than normal in some periods. Foreign exchange market
Major currencies remained highly volatile given investors concerns over the global economy, financial institution problems and liquidity in the global financial markets.
Major currencies, including the US dollar, euro and yen, remained fluctuating from heightened uncertainty in the global economy and financial markets as well as investors concerns over the financial institution problem and liquidity in global financial markets. However, the probability of drastic movements in the yen and euro vis-`a-vis the US dollar, as measured from the implied kurtosis, declined in 2008 Q3. The decline was consistent with market anticipation that monetary policy stances of Japan and the euro area would be more accommodative going forward as economic outlook became gloomier and inflation pressure abated in line with lower oil prices.
Chart 4.10 Trade weighted dollar index (up to 30 September 2008)
Index 84 82 80 78 76 74 72 70 68 Jan 2007

Source: Bloomberg
Apr
Jul
Oct
Jan 2008
Apr
Jul
The baht remained volatile, in line with major and regional currencies.
Major currencies volatilities crucially contributed to fluctuations in regional currencies, including the baht, particularly in August and September. The baht started off by depreciating rapidly following gains in US dollar sentiment, then appreciated against the US dollar after
48
Bank of Thailand
Chart 4.11 Volatility of major currencies

125 120 115 110 105 100 95
Yen/US dollar
Spot (LHS) ( Implied volatility
Per cent (annualized)

21 18 15 12 9 6 3 0.9 0.8 0.7 Spot (LHS)
Per cent (annualized)
Euro/US dollar
18 15 12 9
0.6 0.5 Implied volatility Actual volatility Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2006 2007 2008
6 3
Actual volatility Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2006 2007 2008
Yen/US dollar implied kurtosis

125 120 115 110 105 100 95 Spot (LHS) 3.2 2.8 2.4 2.0 1.6 1.2 0.8 0.4 0.0 0.9 0.8 0.7
Euro/US dollar implied kurtosis

2.0 Spot (LHS) 1.7 1.4 1.1 0.6 Implied kurtosis 0.5 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2006 2007 2008 0.5 0.8
Implied kurtosis Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2006 2007 2008
Source: Bloomberg
Lehman Brothers declared bankruptcy, before reverting again into a depreciating cycle as markets became more risk averse.
Chart 4.12 Baht actual volatility (up to 30 September 2008)
Per cent (annualized) 40 35 30 25 20 15 Actual volatility (Onshore) 10 5 0 Jan Apr Jul Oct Jan 2006 2007
Source: Bloomberg
Actual volatility (Offshore)
Apr
Jul
Oct
Jan 2008
Apr
Jul
Thai equity market In 2008 Q3, the SET index moved along a sharp declining trend due to various factors domestic and global, which included concerns over high domestic inflation and political uncertainty, as well as global equity sell-off from investors concerns over liquidity in global financial
The SET index remained fluctuating in 2008 Q3 and adjusted downwards considerably from the previous quarter.
49
markets and the effects of the financial crisis on global economic growth. However, positive factors also helped cushion the downward movements in the SET over the period, as evidenced during the end of July when oil prices started to decline and most listed companies showed healthy performance.
Chart 4.13 Volatility in the Thai stock market (up to 30 September 2008)
Per cent (annualized) 120 Standard deviation 100 80 60 40 20 0 Jan Apr 2006 Jul Oct
SET index (RHS)
Index 950 900 850 800 750 700 650 600 550
Jan Apr 2007
Jul
Oct
Jan 2008
Apr
Jul
Source: Stock Exchange of Thailand, calculations by Bank of Thailand
Thai government bond market

Government bond yields remained volatile due to shifts in investors expectations regarding future inflation and the direction of monetary policy.
In 2008 Q3, Thai government bond yields fluctuated as investors expectations regarding the direction of monetary policy and inflation shifted. Towards the beginning of the quarter, yields on bonds with maturities of less than 1 year rose in line with the policy interest rate, before adjusting downwards during the end of the quarter once investors perceived that inflationary pressure had subsided and that there was no need for monetary policy to tighten in the near term. At the same time, yields of bonds with maturities of more than 1 year declined progressively, as a result of a drop in inflation expectation and investment diversification from the stock market to the bond market.
50
Bank of Thailand
Chart 4.14 Volatility in the Thai government bond market (up to 30 September 2008)
Per cent (annualized) 24 20 16 12 8 4 0 Jan 2006 Apr Jul Oct Jan 2007 Apr Jul Oct Jan 2008 Apr Jul
Source: Thai Bond Market Association, calculations by Bank of Thailand
In conclusion, the MPC assessed that Thailands financial stability remained sound. The corporate, household and financial sectors were able to withstand adverse risks. However, going forward, risks to financial stability would increase, especially from the global economy and financial markets coupled with fragile domestic demand, which could significantly affect various economic sectors. Therefore the MPC would keep a close watch over these risks going forward.
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5. Inflation Outlook
In 2008 Q2, the Thai economy expanded at a slower pace than the MPC had assessed on account of softer-than-expected private consumption growth, consequent of a rapid increase in the cost of living, as well as weaker-than-anticipated stimulus from government spending. Indeed actual nominal government spending was lower than the amount specified in the budget plan, upon which the MPC based its preliminary assessments. In addition, the portion of the outlay classified as transfers was larger than expected, lowering public consumption spending. Combined with postponements of certain investment projects, owing to rising costs, both public consumption and investment contracted in real terms during 2008 Q2. As a result, overall domestic demand showed clear signs of a slowdown, contributing to greater inventory accumulation than the MPC had expected. However, net exports continued to expand well from sustained export growth momentum, which was partly due to exporters ability to diversify to new markets. The momentum for economic expansion continued into 2008 Q3 on the back of various supporting factors, namely accommodative monetary policy, moderation in world oil prices and inflationary pressures as well as the depreciation in the nominal effective exchange rate, which was favorable for export activities. Nevertheless, several indicators pointed to a weaker economy; in particular, indicators for private investment spending tapered off from deteriorating business confidence, fiscal stimulus continued to moderate from 2008 Q2, and goods export volume began to slow down following more sluggish growth in the major industrial countries (G3). Meanwhile, tourism revenue shrank on a year-on-year basis as domestic political uncertainties bore down on foreign tourists sentiments. Going forward, downside risks to economic growth would become more pronounced. Domestic political uncertainties could result in further postponements of several public investment projects. Meanwhile, trading-partner economies vulnerability to the downturn could dampen the growth of exports of goods and services. In a highly volatile environment, both factors would contribute to delays in private investment and consumers decisions to purchase durable goods.
53
The MPC therefore assessed that the Thai economy would slow down in the latter half of 2008 and begin to pick up in the latter half of 2009, in line with the global economic trajectory and following the amelioration of adverse domestic risk factors. Overall, the growth rates of the Thai economy in 2008 and 2009 were be lower than projected in the previous Inflation Report (July 2008). Price pressures declined significantly but still remained, as the prices of processed food (food at and away from home) and public transportation fares continued to adjust upward following earlier rise in raw food and energy costs. Moreover, the year-on-year rate of increase in the Producer Price Index (PPI) continued to be high. In addition, there remained several items under the Ministry of Commerces price administration that awaited permission for price increases. On the other hand, a decline in world oil prices and a reduction in excise tax on petrol, effective from 25 July 2008 for a period of 6 months, significantly alleviated pressures on costs of production of goods and services in the immediate future. At the same time, other government measures, such as temporary exemption of water charges and fares on certain modes of public transportation for the period of 6 months from 1 August 2008 helped relieve consumers concern over price inflation, thereby allowing for stabilization and later reduction in inflation expectations as world oil prices declined. In the future, price pressures should continue to moderate from both supply- and demand-side factors, most prominent among which would be the leveling off of world prices of oil and non-fuel commodities in line with weakened global economic conditions. Moreover, despite possible short-term acceleration in crop prices from damages caused by flood in some parts of the country, the rise in agricultural product prices should moderate towards the end of the year. Softer economic growth over the next 2-3 quarters should also help reduce price pressures. Based on these reasons, the MPC assessed that both headline and core inflation would be lower than previously projected for both 2008 and 2009. In the economic and inflation projections for the upcoming periods, the MPC exercised caution in considering the assumptions used. The projections below are presented as fan charts, which are obtained from the macroeconometric model and incorporates the MPCs judgments. The fan charts reflect uncertainties surrounding a range of
54
Bank of Thailand
events and are consistent with the assumption that the policy interest rate remains at the current level of 3.75 per cent per annum from 2008 Q4 to 2010 Q3, higher than the level assumed in the previous Inflation Report. The assumption is consistent with the decisions in the MPC meetings on 27 August 2008 to raise the policy rate by 0.25 percent per annum, which was effective immediately and on 8 October 2008 to maintain the policy rate at 3.75 per cent per annum.
Forecast assumptions
In forming economic and inflation forecasts for the next 8 quarters, the MPC needed to make the most plausible baseline assumptions on various factors including international economic and financial conditions, world commodity prices, and fiscal conditions. These assumptions are summarized below. International economic and financial conditions Global economic growth in 2008 Q2 had been less robust than the MPC had anticipated in the previous Report from weaker expansion in Japan, the euro area and Asian countries. Going forward, the global economy would likely slow down by more than the MPC had previously assessed as the financial crisis in the US and other countries intensified following bankruptcy of large financial firms and the seizing up of liquidity after financial institutions lost confidence in making new loans and sought to reduce exposures to risky assets (deleveraging). The ability to provide credits would be impaired with adverse consequence for the overall functioning of the economy. Important economic data, such as US employment and housing market conditions, also pointed towards weaker economic conditions. The MPC therefore viewed that downside risks to US output growth were considerably higher and that the US economy would slow down for the rest of 2008. Nevertheless, the MPC retained the growth assumption made in the previous Report for the US in 2008, as the US economy grew more briskly than anticipated in 2008 Q2 at the rate of 2.1 per cent. With the view that the impact of the financial crisis on US economic growth should be progressively more pronounced, the MPC thus revised down US growth assumption considerably for 2009.
Going forward, risks to the US economic growth significantly increased from problems in the financial sector.
55
The MPC viewed that the FOMC would ease monetary policy further in the last quarter of this year.
In line with the assumption on US economic growth, the MPC also viewed that even though the FOMC had decided to maintain the Fed funds rate and the discount rate at 2.0 and 2.25 per cent per annum, respectively, at the latest meeting on 16 September 2008, the prolonged financial turmoil and worsened US growth prospects could lead the FOMC to ease monetary policy further going forward. The MPCs assumption thus incorporated the scenario that the FOMC would lower the policy rate by an additional 0.5 per cent per annum in 2008 Q4, after which the Fed funds rate would be constant at 1.5 per cent per annum until the end of the forecasting period. In 2008 Q2, the euro area economy grew by 1.4 per cent year-on-year, slower than 2.1 per cent in the previous quarter and considerably lower than anticipated. Furthermore, several economic indicators showed clear signs of further weakening going forward. Meanwhile, financial institutions in Europe would be exposed to greater risks from a high degree of financial integration with the US. The MPC therefore revised down the assumptions for the euro areas economic growth throughout the entire forecasting period. The Japanese economy grew by 0.7 per cent year-on-year in 2008 Q2, slowing down from 1.2 per cent in the previous quarter, and continued on a decelerating path as trading partners economies stalled. Therefore, the MPC also revised down output growth assumptions for Japan for both 2008 and 2009. The Asian economy slowed down in 2008 Q2, as both domestic demand and exports softened and would continue to decelerate in line with weaker growth prospects in major economies than assumed in the previous Report. The MPC thus revised down the assumptions on Asian economic growth throughout the forecasting period (see box for further information). Overall, the MPC assessed that the overall growth rate of Thailands trading-partner economies would be lower than assumed in the previous Report and that growth would be lower in 2009 than in 2008.
The MPC revised down the growth assumptions on the euro areas economy, Japanese and Asian economies throughout the forecasting period.
56
Bank of Thailand
The slowdown of Asian economies Economic activities in Asia have so far been expanding well, from both domestic demand and exports. Nonetheless, going forward, downside risks to both growth drivers are expected to increase, which can potentially lead to a period of economic slowdown.
Table: World economic forecasts
Country
(Real GDP) 2007 3.8 2.2 2.6 2.1 11.9 5.7 6.3 5.0 7.7 6.3 7.3 6.3 4.8
World
G3 United States EU Japan
GDP (%yoy) 2008 2009 As of Jun 08 As of Sep 08 As of Jun 08 As of Sep 08 2.9 2.9 2.8 2.5 1.5 1.7 1.3 10.1 4.4 4.9 4.5 5.1 5.5 5.3 5.9 4.9 1.8 1.3 0.9 9.9 4.3 4.4 4.4 4.2 5.5 4.7 5.9 4.8 1.7 1.4 1.5 9.4 4.8 4.9 4.9 5.5 5.5 5.4 5.9 5.0 1.4 0.9 0.9 9.1 4.4 4.2 4.3 4.6 5.1 4.8 5.6 4.6
East Asia
China Taiwan Hong Kong South Korea
Southeast Asia
Singapore Malaysia Philippines Indonesia Thailand
Note: Forecast for world economy is weighted on 70 countries Source: Consensus Economics Inc. as of 9 June 2008 and 8 September 2008
In the second quarter of 2008, the Asian Chart 1 Contribution to growth in 2008 Per cent economies started to show signs of slowing down, as 15 Domestic demand Net export consumers purchasing power dwindled from surging 10 domestic oil and commodity prices. Consumer and 5 business confidence has also been affected by the 0 weakening prospect of the global economy, worsening Q1 Q2 Q1 Q2 Q1 Q2 Q1 Q2 Q1 Q2 Q1 Q2 Q1 Q2 -5 financial market conditions, and uncertainty over -10 Q1 Q2 political situation in certain countries. With declining -15 confidence, financial institutions have further tightened Malaysia Hong Kong Singapore Indonesia Taiwan Thailand South Korea Philippines their lending criteria and scaled down lending activities. Source: Calculations by the Bank of Thailand, based on World Economic Coupled with tightening monetary policy in the Outlook in April 2008, IMF. previous period in response to rising oil prices and growing risk aversion from the worsening financial turmoil, financial conditions could continue to tighten further.
Inflation Report October 2008 Inflation Report October 2008
57
Chart 2 G3 economies remain a significant final market Exports, which have been the key driver of for Asian exports economic growth in recent years, also began to grow Asian exports at a slower pace. Although intra-regional trade has (100%) increasingly contributed to Asian export growth, a study conducted by the Asian Development Bank Final demand (ADB) suggests that around 61.3 per cent of the regions direct and indirect exports 1/ has the G3 Asia G3 Others economies as final destinations. Thus, economic (21.2%) (61.3%) (17.5%) expansion in the G3 economies is of considerable Source: The Asian Development Bank 2007 importance for the outlook of Asian exports. In fact, the recent slowdown of exports in some regional countries including China, South Korea and Singapore can be largely explained by slowing demand from the G3. In addition, signs of a significant slowdown of exports to China, an important market for raw materials and intermediate goods in the regional production network for goods with final destination in G3 economies, have been detected.
Going forward, adverse consequences from the financial turmoil could further weaken the G3 economies and raise the probability of recession there. Meanwhile, regional economies domestic demand has weakened, posing a downside risk to the momentum of growth. However, the downturn in regional economies will not be severe if the G3 economies do not fall into recession. In addition, policymakers in China and Taiwan have started to relax monetary policy through interest rate cuts and reduction in the required reserve ratios to help cushion the impact as inflation started to decline there. As the majority of the regional countries have sound fiscal positions, as reflected by the ratios of public debt to GDP, more room exists for expansionary fiscal policy. Several regional economies have already implemented fiscal stimulus measures including reduction in income tax, provision of funding for small and medium enterprises as well as subsidies for public utilities. In sum, Asian economies will likely observe a growth slowdown from softening domestic and external demand. But policymakers could still mitigate the effect of slowing activities through the use of fiscal policy. Countries with declining inflationary pressures may also be able to ease monetary policy. The available policy tools should help avoid a sharp downturn of economic activities amidst the global economic slowdown and rising uncertainties.
1/
Note: Calculation based on the Asian Input Output Table (AIO table) in 2000, by the Asian Development Bank (ADB). The current G3 final demand figures are likely to be lower than in the ADB study.
58
Chart 5.1 Assumptions on trading partners growth

Annual percentage change 4 US 3 2 1 0 Q1 Q1 Q1 Q1 Q1 2006 2007 2008 2009 2010 Annual percentage change 4 Japan 3 Jul 08 estimates 2 1 Oct 08 estimates 0 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Jul 08 estimates 3 Jul 08 estimates Oct 08 estimates 0 Q1 Q1 Q1 Q1 Q1 2006 2007 2008 2009 2010 Annual percentage change 10 Asian region 9 8 Jul 08 estimates 7 Oct 08 estimates 6 5 Q1 Q1 Q1 Q1 Q1 2006 2007 2008 2009 2010 Oct 08 estimates 2 1 Annual percentage change 4 Euro area
Annual percentage change 7 Trading partners 6 Jul 08 estimates 5 4 3 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Oct 08 estimates
Source: Bank of Thailand estimates
Since the publication of the previous Report, the US dollar had strengthened by more than the MPC had anticipated. This was partly due to sizable capital outflows from regional economies to relieve the liquidity freeze in the US financial system as well as to reduce exposures to risky assets (risk aversion). Going forward, as Asian and euro area economic growth became more sluggish, the MPC anticipated that regional currencies and the euro would weaken further vis--vis the US dollar. The assumption was consistent with current market expectations, embedded in the price of risk reversal option strategies, which indicated a higher probability of US dollar appreciation than depreciation over the next year. Meanwhile, the Japanese yen would strengthen moderately against the US dollar in 2008 due to the unwinding of carry trades; however the yen was likely to weaken in 2009 from continued sluggishness in the Japanese economy.
The MPC viewed that regional currencies would depreciate vis--vis the US dollar.
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World commodity prices

The MCP revised down the assumption on Dubai oil prices following the recent trend in oil prices and anticipated global economic slowdown.
Over the past few months, world oil prices declined to much lower levels than previously anticipated, in line with weakening global growth. Together with the deteriorating prospects for the global economy, the MPC revised down the assumption on Dubai oil prices significantly throughout the forecasting period compared to those in the previous Inflation Report.
Chart 5.2 Assumptions on Dubai oil price
US dollars/barrel 150 Jul 08 estimates 125 100 Oct 08 estimates 75 50 25 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010
The assumptions on the world non-fuel commodity prices and the farm price index for 2009 were revised down.
The world non-fuel commodity prices were higher than expected in the first two months of 2008 Q3 and would likely remain at high levels for the rest of 2008. Thus, the MPC revised up slightly the growth assumptions on the world non-fuel commodity prices for 2008; and, in keeping with the view on global growth, revised down the assumptions for 2009. Meanwhile, the MPC revised down the farm price index for both 2008 and 2009 as the recent prices of agricultural products in Thai baht terms, especially rice, began to decline.
60
Bank of Thailand
Chart 5.3 Assumptions on world commodity prices

World non-fuel commodity prices
Annual percentage change 30 20 10 0 -10 Q1 Q1 2006 2007 Annual percentage change 30 20 10 0 Q1 Q1 2006 2007
Jul 08 estimates Q1 2008

Farm price index
Q1 2009
Oct 08 estimates Q1 2010
Jul 08 estimates Oct 08 estimates Q1 2008 Q1 2009 Q1 2010
Fiscal conditions The MPC expected general government consumption in fiscal years 2008 and 2009 to total 1,092.1 and 1,202.2 billion baht respectively, lower than the previous assumptions of 1,161.3 and 1,225.4 billion baht respectively.
Chart 5.4 Assumptions on general government consumption (at current prices) The MPC assumed general government consumption for fiscal years 2008 and 2009 to be 1,092.1 and 1,202.2 billion baht, respectively.
Billion baht 375 350 325 300 275 250 225 200 175 Q1 2006
Jul 08 estimates
Oct 08 estimates
Q1 2007
Q1 2008
Q1 2009
Q1 2010
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The MPC assumed public investment for fiscal years 2008 and 2009 to be 599.5 and 658.7 billion baht, respectively.
The MPC anticipated general government investment for fiscal years 2008 and 2009 to be 326.5 and 366.0 billion baht, respectively. Meanwhile, state-owned enterprise investment in fiscal years 2008 and 2009 were assumed to be 273.0 and 292.7 billion baht, respectively. As a result, overall public investment, which consisted of general government and state-owned enterprise investment, would stand at 599.5 and 658.7 billion baht in fiscal years 2008 and 2009, lower than the previous assumptions of 631.8 and 697.1 billion baht.
Chart 5.5 Assumptions on public investment (at current prices)
Billion baht 240 Jul 08 estimates 220 200 180 160 140 120 100 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Oct 08 estimates
Significantly lower assumptions on nominal public spending could be attributed to various reasons. For fiscal year 2008, the MPC recognized that the actual budget disbursement rate was lower than previously expected both for consumption and investment expenditures. For fiscal year 2009, the MPC assumed that the central governments budget disbursement rate would remain on target, but the amount in the budgets for both current and capital spending classified as transfers would rise, thereby reducing the total amount of spending that could be injected as public consumption and investment. Meanwhile, local governments budget disbursement rate was revised down along with state-owned enterprises investment spending, as plans for several investment projects were still unclear.
62
Bank of Thailand
Assumptions on minimum wages The MPC maintained the previous assumption for minimum wages for Bangkok and surrounding provinces in 2008 at 199 baht per day on average. From 2009 onward until the end of the forecasting period, the MPC lowered the rate of growth of minimum wages to 3.4 percent year-on-year, in line with the expected decline in headline inflation, following a slowdown in oil and commodity prices as well as weaker domestic demand going forward. Assumptions on inventory accumulation The MPC assumed that inventory accumulation over the next 8 quarters would increase in certain quarters. Accumulation of inventory would be necessary to restore the inventory that had been continually depleted during the past 2-3 years. As a result, in those quarters, inventory accumulation would have a positive contribution to GDP.
The MPC revised down the assumptions on minimum wages, in line with the inflation outlook and the slowdown in economic growth.
Output and inflation projections

Output projection Output data for 2008 Q2 together with preliminary economic indicators for 2008 Q3 revealed a somewhat softer growth momentum than the MPC had assessed in the previous Report, largely from shrinking government spending and a slowdown in private spending. With regard to the economic outlook over the next 8 quarters, the MPC viewed that the overall picture would be softer than that painted in the previous Report. Weaker growth would stem from softer-than-expected growth momentum as discussed in the previous paragraph along with more downside risks from domestic and external factors. Consequently, the recovery of the overall economy would be further delayed than previously anticipated. Prominent among the risk factors would be continuing political uncertainties, which would cause several public investment projects to be delayed; weakening trading partners economies, which would lead to further deceleration in exports of goods, while exports of services, particularly tourism, would be affected both by the volatile political situation, which might affect tourists sentiment, and also by lower receipts from tourists as the global economy slowed down. Altogether, these factors would have an impact on the private
63
investment climate and cause consumers to delay their decisions to purchase durable goods. Overall, the Thai economy would slow down further for the rest of 2008 and continued along a decelerating path during the first half of 2009 before picking up gradually in the latter half of 2009. The MPC revised the forecasts of individual GDP components as follows. Private consumption in 2008 was expected to grow at a lower rate than previously projected. This was due to softer-than-expected growth momentum in 2008 Q2 along with weak consumer confidence, which was sensitive to political uncertainties and worsening external economic conditions. The impact would be largely felt in durable consumption, the pickup of which could be delayed. Nevertheless, various positive factors should help cushion private consumption growth; for instance, declining inflation, which would help preserve consumers purchasing power going forward, high farm income growth as well as accomodative monetary policy conditions, which, despite some recent tightening, remained supportive of economic expansion. Once the global economy showed clear signs of improvement in the latter half of 2009 and negative domestic factors passed from view, consumer confidence was likely to strengthen and lead to a recovery in private consumption in the latter half of 2009. Private investment in 2008 grew at a slower pace than expected from worsening business sentiment over the past period, and would likely expand modestly going forward even as production costs slowed down following a decline in world oil prices to much lower levels than previously assumed. Furthermore, delays in large public infrastructure investment projects, which were expected to increase the rates of return and therefore provide incentive for private investment, would stall private investment growth. In spite of these mitigating factors, high capacity utilization in several economic sectors, a significant decline in world oil prices as well as an accomodative monetary policy stance would continue to support private investment growth going forward and allow it to pick up after mid-2009. Government spending was expected to help support economic expansion in 2009. Despite lower nominal government spending than previously anticipated in the last Report, the year-on-year rate of increase
64
Bank of Thailand
would be significantly higher compared to that for 2008. Moreover, as inflation declined, government spending in real terms would not fall by as much as previously projected. Exports of goods and services were projected to slow down by more than previously forecasted, as trading-partner economies would expand at significantly lower rates than previously expected. Nonetheless, a moderate depreciation of the baht along with regional currencies vis--vis the US dollar and declining inflation would enhance price competitiveness of exports by more than previously projected, and partly make up for the impact of a slowdown in external demand. As export growth in 2008 Q2 was higher than expected, overall exports would grow at a slightly faster pace than previously expected for 2008. In 2009, however, exports would grow at a more moderate pace than previously projected and began to recover following a gradual recovery in the global economy from the latter half of 2009 onwards. Imports of goods and services in 2008 were projected to expand at a comparable rate to previous forecasts from higher-thanexpected export growth, which somewhat made up for a slowdown in the demand for imports from softer domestic demand. In 2009, imports should slow down by more than previously expected, consistent with a delayed recovery in private demand and a slowdown in the export sector, which would make a dent on raw material import growth. Moreover, the slightly weakened baht would raise import cost in local currency terms and erode import volume somewhat. Nonetheless, imports were expected to accelerate in the latter half of 2009 following a recovery in domestic demand and exports. The projected slowdown of both exports and imports led the MPC to assess that the current account (including reinvested earnings) would adjust in the same direction as projected in the previous Report; that is, the current account in 2008 should be in smaller surplus than that recorded in 2007 and should be close to balance in 2009. Inflation projection Headline and core inflation in 2008 Q3 started to decelerate from 2008 Q2 to levels that were lower than previously assessed by the MPC from lower-than-expected oil prices and temporary government measures aimed at alleviating the rise in the cost of living, such as
In 2008, the current account balance was expected to register a smaller surplus than the previous year and become close to balance in 2009.
65
exemption of water charges and fares on certain modes of public transportation. Nonetheless, gradual pass-through of production costs to prices of goods and services was still evident, for example, adjustments in prices of processed food (at and away from home) and public transportation fares on the back of higher costs in raw food and energy in previous periods. Moreover, the Producer Price Index (PPI) continued to increase at a high year-on-year rate while there remained several items under Ministry of Commerces price administration that awaited permission for upward price adjustment. As a result, inflationary pressure, though lower than expected, still remained.
Chart 5.6 Contribution to headline and core inflation
Headline inflation
Tobacco and alcoholic beverages (2.8%) Recreation and education (5.8%) Transportation and communication (22.0%)
Per cent
Core inflation
Tobacco and alcoholic beverages (3.7%) Recreation and education (7.7%) Transportation and communication (22.0%) Medical and personal care (8.0%) Per cent Housing and furnishing (26.5%) 4.0 Apparel and footwear (4.5%) . Food and beverages (27.7%) 3.5 ( ) weight in Core CPI 3.0
Medical and personal care (6.0%) Housing and furnishing (23.9%) 10 Apparel and footwear (3.4%) Food and beverages (36.1%) 9 ( ) weight in Headline CPI 8 7 6 5 4 3 2 1 0 -1 -2 Jan Jul Jan Jul Jan Jul Jan Jul 2005 2006 2007 2008
2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 Jan Jul Jan Jul Jan Jul Jan Jul 2005 2006 2007 2008
Source: Trade and Economic Index Bureau, Ministry of Commerce, calculations by the Bank of Thailand
Chart 5.7 Month-on-month seasonally adjusted headline and core inflation
Per cent 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0
Headline inflation
Per cent 2.0 1.5 1.0 0.5 0.0 -0.5
Core inflation
Jan Jul Jan Jul Jan Jul Jan Jul 2005 2006 2007 2008
Source: Calculations by the Bank of Thailand
-1.0 Jan Jul Jan Jul Jan Jul Jan Jul 2005 2006 2007 2008
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Bank of Thailand
Over the next 8 quarters, inflationary pressure was expected to be significantly lower than previously projected from a much lower assumption on oil prices, decelerating farm prices and weaker demand pressure, as well as the psychological impact of government measures to ease living costs, which was expected to help moderate calls for wage increase. The MPC assessed that headline and core inflation would continue to decelerate in 2008 Q4 and inflationary pressure would remain relatively low during the beginning of 2009 even as government measures to ease living costs were lifted. However, inflation would be higher in the latter half of 2009 from demand pressure as the economy started to recover.
Both headline and core inflation were expected to be lower than previous projections in 2008 and 2009.
Assessment of risks
The output and inflation projections given above were based on assumptions that the MPC considered most plausible while holding the policy interest rate unchanged. At the same time, the MPC deemed that many risks, from both internal and external sources, could cause the projections to deviate from the base case. Important risk factors are as follows. Risk factors in the output projection Important risk factors which could lead to lower growth outlook than that painted by the baseline projection were lower economic growth rates of Thailands trading partners, particularly in 2009, and weaker public spending if the budget disbursement rate was lower or large investment projects were further delayed in comparison with the baseline assumptions. The MPC viewed that the current financial crisis which originated in the US could have such a large impact on the global economy that Thailands trading partners could grow at a lower rate than they did after the dotcom bubble burst in 2001. The US economy could fall into recession and recover gradually, as significant damage to financial institutions balance sheets would disrupt real economic activities. In such an event, the housing market would continue to contract and consumer and business confidence would deteriorate further while the ability to make new loans would be significantly impaired with severe consequences on the expansion of the business sector, purchasing power
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and employment. At the same time, the euro areas economy, already beginning to slow down, could be further affected as large financial institutions remained fragile through their deep connection with the US financial system and exposure to the US housing market. Furthermore, the possibility and extent of required fiscal stimulus in Europe remained limited, which could delay the economic recovery further. The economies of Japan and Asia would be affected via close ties with the US and Europe through trade and investment. Another important downside risk factor stemmed from domestic political uncertainties, which could impact on the stability of the government. Under such circumstances, public spending would be lower than assumed in the baseline case as the ability to disburse the budget would be reduced while large investment projects would likely face further delays, undermining investors confidence. Furthermore, the impact would be felt on tourism should tourists concerns over political events in Thailand remain unabated. World oil price fluctuation remained a risk factor that could lead to positive or negative deviations from the baseline projection, with a probability that Dubai oil price could deviate from the baseline assumption, which averaged at 104.1 and 95 US dollars per barrel in 2008 and 2009, respectively. Factors that could buoy oil prices to levels higher than the baseline assumption included political tension in certain oil producing and exporting countries, natural disasters and remaining supply constraints. Risk factors that could depress oil prices further than in the baseline assumption were the possibility that world demand would weaken as a result of widespread financial crisis. The MPC assumed that the high-case scenario would be consistent with the baseline Dubai oil price plus one standard deviation, which would raise the oil price average to 108.6 and 127.9 US dollars per barrel in 2008 and 2009, respectively. The MPC assumed that the low-case scenario would be equivalent to the baseline assumption minus 0.5 standard deviation, which would lower the average oil price to 101.9 and 78.5 US dollars per barrel in 2008 and 2009, respectively. As oil exporting countries were unlikely to allow prices to fall precipitously without reducing oil production, the low-case assumption took on a 0.5 standard deviation from the base case instead of 1 standard deviation used in the high-case assumption.
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Bank of Thailand
Beside the possibility of lower oil prices, another upside risk factor for growth was the possibility that regional economies would not be as affected by a slowdown in major industrial economies as outlined in the baseline scenario, partly because regional economies had, to some extent, room for fiscal stimulus. Overall, the MPC viewed that uncertainties increased from the previous Report, and gave considerably more weight to the downside risks than to the upside risks. As a result, the fan chart is slightly wider than that of the previous Report and is skewed downwards to reflect larger downside risks.
Chart 5.8 GDP growth forecast
8 6 4 2 0 Q1 2006
Annual percentage change 8 6 4 2 0 Q1 2007 Q1 2008 Q1 2009 Q1 2010
The fan chart for GDP growth is skewed downwards reflecting larger downside risks than upside risks.
Risk factors in the inflation projection The MPC assessed that major risk factors that would cause inflation to be higher than the baseline projections continued to originate from movements in oil, commodity and agricultural prices. Oil prices could follow the high-case scenario as already outlined while agricultural prices could increase by more than the baseline case, should volatile climate and natural disasters cause damage to crops and livestock. This would exert an upward pressure on inflation through higher costs of production and transportation. In such a case, inflation could decline at a slower pace and remain higher than in the baseline case.
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On the other hand, world oil prices could be lower, particularly should the global economy slow down by more than assumed in the baseline case. Commodity prices could also become lower under this scenario. Both factors would lead to lower inflation than expected in the baseline case. Moreover, government measures such as a reduction in the excise tax on petrol as well as an exemption on water charges and fares on certain public transports could be extended. The extension of government measures would reduce inflationary pressure relative to the baseline case, which assumed that the measures would expire after 6 months as previously announced. Overall, the MPC assessed that, the downside risks would dominate at the beginning of the forecasting period, consistent with the risk projection for GDP growth. As the global and Thai economies were projected to recover towards the end of the forecasting period, the upside risks to inflation would begin to outweigh the downside risks. Therefore, the fan chart for headline inflation is skewed downwards at the beginning of the forecasting period and skewed slightly upwards towards the end. Meanwhile, the fan chart for core inflation is skewed downwards at the beginning, similar to that of headline inflation, and then becomes balanced towards the end of the forecasting period.
Chart 5.9 Headline inflation forecast The fan chart for headline inflation is skewed downward at the beginning of the forecasting period reflecting downside risks on economic growth; it is skewed upwards towards the end from the recovery of the global and Thai economies, which would exert upward pressure on inflation.
8 6 4 2 0 Q1 2006 Q1 2007 Q1 2008 Q1 2009
Annual percentage change 8 6 4 2 0 Q1 2010
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Bank of Thailand
Chart 5.10 Core inflation forecast
4 3 2 1 0 Q1 2006 Q1 2007 Q1 2008
Annual percentage change 4 3 2 1 0 Q1 2009 Q1 2010

The fan chart for core inflation is skewed down at the beginning of the forecasting period before becoming more balanced towards the end of the forecasting period.
With regard to the forecast probability distribution for 2008 and 2009, the MPC projected that output growth, obtained from averaging the darkest forecast range of each quarter over the year, would be in the ranges between 4.3-5.0 and 3.8-5.0 per cent with probabilities of approximately 88.7 and 76.1 per cent, respectively.
Table 5.1 Probability distribution of GDP growth forecast 2008 Unit: % < 2.0 2.0 - 2.5 2.5 - 3.0 3.0 - 3.5 3.5 - 4.0 4.0 - 4.5 4.5 - 5.0 5.0 - 5.5 5.5 - 6.0 6.0 - 6.5 6.5 - 7.0 7.0 - 7.5 > 7.5 Q3 0 0 2 10 27 35 21 6 1 0 0 0 0 Q4 3 9 19 27 24 13 4 1 0 0 0 0 0 Q1 9 13 20 22 19 11 5 1 0 0 0 0 0 Q2 4 6 10 15 19 18 14 8 4 2 0 0 0 2009 Q3 0 1 2 5 9 14 17 18 15 10 6 2 1 Q4 0 0 1 3 6 10 14 17 17 14 9 5 3 Q1 0 0 1 2 5 8 13 16 17 15 11 7 5 2010 Q2 0 0 1 3 6 9 13 16 16 14 10 6 5 Q3 0 1 2 4 7 10 14 16 15 13 9 6 5
Output growth for 2008 and 2009 was projected to be in the ranges of 4.3-5.0 and 3.8-5.0 per cent, respectively.
71
Headline inflation for 2008 and 2009 was projected to be in the ranges of 6.0-6.5 and 3.04.0 per cent, respectively.
Headline inflation was projected to average between 6.0-6.5 per cent in 2008 with a probability of approximately 86.8 per cent, and between 3.0-4.0 per cent in 2009 with a probability of approximately 58.3 per cent. The current projection was lower than the previous projection mainly because of the downward revision in oil price assumptions.
Table 5.2 Probability distribution of headline inflation forecast 2008 Unit: % < 0.5 0.5 - 1.0 1.0 - 1.5 1.5 -2.0 2.0 - 2.5 2.5 - 3.0 3.0 - 3.5 3.5 - 4.0 4.0 - 4.5 4.5 - 5.0 5.0 - 5.5 5.5 - 6.0 > 6.0 Q4 0 0 0 0 0 0 1 4 12 25 30 20 9 Q1 0 0 0 1 4 8 14 19 20 16 10 5 2 Q2 1 2 4 8 12 15 16 15 12 8 4 2 1 2009 Q3 2 2 5 8 11 14 15 14 12 8 5 3 2 Q4 2 2 4 7 11 14 15 14 11 8 6 3 3 Q1 5 5 8 12 14 14 13 11 8 5 3 2 1 2010 Q2 4 4 7 11 13 14 13 11 9 6 4 2 2 Q3 2 3 6 9 12 14 14 12 10 7 5 3 3
Core inflation for 2008 and 2009 was projected to be in the ranges of 2.0-2.5 and 2.0-3.0 per cent, respectively.
Meanwhile, the MPC projected core inflation in 2008 to average in the range of 2.0-2.5 per cent with a probability of approximately 95.7 per cent. As for 2009, it was projected to average in the range of 2.03.0 per cent with a probability of approximately 90.0 per cent.
Table 5.3 Probability distribution of core inflation forecast 2008 Unit: % <0 0.0 - 0.5 0.5 - 1.0 1.0 - 1.5 1.5 - 2.0 2.0 - 2.5 2.5 - 3.0 3.0 - 3.5 > 3.5 Q4 0 0 0 0 7 41 47 4 0 Q1 0 0 0 0 3 17 40 34 5 Q2 0 0 0 2 11 26 36 21 4 2009 Q3 0 1 4 11 22 30 24 8 1 Q4 0 1 4 11 22 28 22 10 3 Q1 2 5 13 22 26 20 10 3 1 2010 Q2 2 5 13 21 25 20 10 4 1 Q3 1 4 11 19 24 21 12 5 2
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Bank of Thailand
Forecasts by research houses

Output growth projections for 2008 from various research houses polled by Reuters (Thailand) averaged at 4.9 per cent, close to the previous projection of 4.8 per cent. For 2009, research houses expected that the Thai economy would expand by 5.0 per cent, close to the average of the previous survey for 2009. At the same time, headline inflation for 2008 was forecasted to average at 6.7 percent, lower than the average of the previous survey at 6.9 percent, primarily on the back of a decline in world oil prices over the recent periods. However, the headline inflation forecast for 2009 averaged at 4.0 percent, higher than the previous forecast.
Table 5.4 GDP growth forecasts by various research houses 2 Jul 08 2008 Capital Nomura DBS Bank Kasikorn Research Lehman Brothers Phatra Securities SCB Securities Standard chartered TISCO Securities Average NESDB
1/ 2/
30 Sep 08 2009 4.8 4.7 5.0 6.0 4.7 5.5 4.5 5.4 5.1 n.a. 2008 4.9 5.0 5.0 4.4 5.1 5.1 4.7 5.2 4.9 5.2-5.7 2/ 2009 4.8 4.7 5.0 5.4 4.7 5.3 4.5 5.4 5.0 n.a.
4.6 5.0 4.9 4.2 4.6 5.0 4.7 5.2 4.8 4.5-5.5 1/
Estimated on 26 May 2008 when GDP figures for 2008 Q1 were released Estimated on 25 August 2008 when GDP figures for 2008 Q2 were released Source: Reuters, NESDB and average figures calculated by the Bank of Thailand
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Table 5.5 Headline inflation forecasts by various research houses 2 Jul 08 2008 Capital Nomura DBS Bank Kasikorn Research Lehman Brothers Phatra Securities SCB Securities Standard chartered TISCO Securities Average NESDB
1/ 2/
30 Sep 08 2009 2.7 2.8 3.7 4.5 3.9 4.0 3.8 3.3 3.6 2008 7.2 6.5 6.3 8.0 6.5 6.3 6.4 6.5 6.7 6.5-7.0
2/
2009 4.0 4.5 3.0 5.0 3.7 3.6 3.8 4.1 4.0 n.a.
6.0 6.4 7.4 7.5 7.2 7.5 6.4 6.7 6.9 5.3-5.8
1/
n.a.
Estimated on 26 May 2008 when GDP figures for 2008 Q1 were released Estimated on 25 August 2008 when GDP figures for 2008 Q2 were released Source: Reuters, NESDB and average figures calculated by the Bank of Thailand
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Bank of Thailand
6. Conclusion
In 2008 Q3, the global financial crisis which intensified in September resulted in a clear shift in the balance of risks for the Thai economy compared to the beginning of the quarter. Initially, at the beginning of the quarter, risks to inflation remained elevated given the rising trend of oil prices, which in turn led to an increase in costs and prices for domestic consumers as well as higher inflation expectations going forward. Monetary policy therefore had to be tightened in order to maintain economic stability. In the latter part of the quarter, in line with a slowdown of world economy, oil prices in the world market decreased rapidly, reducing pressure on prices. However, some price pressures remained as a result of the continued adjustment of prices of goods as a result of the pass-through of higher costs in previous periods. These included food at and away from home, as well as prices under authorities price administration measures. However, given the slowdown in the export sector in line with the world economy, and fragile domestic demand, which would be further affected by political uncertainty, the cost-to-price pass-through for goods and services would be smaller going forward. Therefore, the overall risks to inflation were expected to weaken drastically from the projections made by the MPC in the previous Report. This was in tandem with the downward adjustments of the forecast of core and headline inflation for the next eight quarters. However, the increased risks to growth were also reflected by the MPCs downward adjustments of the forecast for economic growth. With the aforementioned shift in the balance of risks, the need for tighter monetary policy to maintain price stability receded. The MPC therefore decided to maintain the policy rate at 3.75 per cent per annum at the meeting on 8 October 2008. Additionally, the MPC also expressed an intention to monitor all risk factors closely. Should risks to the economy become larger-than-expected, the MPC would stand ready to implement the appropriate policy stance.
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Report: Economic/Business Information Exchange Program Between the Bank of Thailand and the Business Sector
As of 30 September 2008
Overall summary The Economic/Business Information Exchange Program between the Bank of Thailand and 80 business firms throughout the country conducted in 2008 Q3 revealed that overall sales of businesses, private consumption and investment declined from the previous quarter partly due to uncertainty with regards to the political situation. Nevertheless, export growth remained healthy. Costs of production and inflationary pressures moderated in line with the decrease in oil prices. As for the economic outlook for the fourth quarter of 2008, businesses expected that domestic demand, both through private consumption and investment, would continue to slow down as a result of fragile consumer confidence and increased external risks resulting from the prolonged US financial crisis.
Private consumption. Overall private consumption declined from the previous quarter, reflecting lower sales of goods and services. Consumer confidence remained fragile due to political uncertainties. As a result, consumers exercised greater caution in their spending, purchasing only necessary items, in spite of economic stimulus measures by the government. As for the final quarter of 2008, businesses anticipated that private consumption would continue to decline. Private investment. Private investment slowed down from the previous quarter, from pressures resulting from elevated production costs and oil prices, despite having declined somewhat in this quarter. Political uncertainties led businesses to postpone their investment decisions and exercise greater caution in business operation. On the investment front, although Japanese investors were concerned with political uncertainty in the short run, they still had confidence in the Thai economys commercial and investment outlook over the long run. The reasons for this were strong economic fundamentals and qualified labor force in Thailand. Exports. Overall exports continued to expand favorably in this quarter owing to demand from new markets, particularly those in Asia and the Middle East which continued to grow, together with the depreciation of the Thai baht against the US dollar in the previous period. Nevertheless, it was expected that the financial crisis in the US would have an adverse effect on foreign demand, which would become a threat to Thai exports in the near future. In response, exporting firms needed to monitor and assess the situation closely as well as improve their business strategies, such as pursuing greater diversification into new export markets. Costs and prices. Business operating costs declined from the previous quarter mainly due to the fall in oil and raw material prices, in line with a decline in inflationary pressure. Consequently, most businesses had yet to adjust their prices. Although there was a minimum wage adjustment, most businesses were not affected as they were still able to absorb the increase in their labor costs. However, businesses attempted to improve their productivity and expand their distribution channels in order to increase their profit margins. Credit. The demand for corporate and household loans expanded slightly from the previous quarter, particularly in loans for working capital and inventory build-up. The demand for fixed asset investment loans increased slightly, while household demand for residential loans increased significantly. Nonetheless, compared to the previous quarter, financial institutions tightened their credit standards as a result of uncertainty in economic conditions and growing concerns regarding credit quality, particularly for loans granted to small and medium-sized enterprises. Business limitations and risk factors. Most businesses viewed that major domestic limitations and risk factors were, among others, high costs of production and economic uncertainties resulting from political instability. On the external side, the financial crisis in the US would be the key risk factor for business operations in the near future. It should be noted that businesses expressed increased concern with regards to the decline in demand from both domestic and foreign markets.
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Inflation Report

The Monetary Policy Committee:

Inflation Report October 2008

Thailand Monetary Policy Strategy

The Monetary Policy Instrument

Inflation Report October 2008

2. Recent Developments in Inflation and Economic Conditions

3. Monetary Conditions in the Last 3 Months

4. Financial Stability Conditions and Outlook

Inflation Report October 2008

Inflation Report October 2008

Inflationary outlook and monetary policy

Inflation Report October 2008

4 3 2 1 0 Q1 2006 Q1 2007 Q1 2008

Annual percentage change 4 3 2 1 0 Q1 2009 Q1 2010

Inflation Report October 2008

Inflation Report October 2008 October 2008 Inflation Report

Bank of Thailand of Thailand Bank

2. Recent Developments in Inflation and Economic Conditions

Inflation Report October 2008

2.3 1.1 6.5 2.4 3.3 -

Source: Trade and Economic Index Bureau, Ministry of Commerce

Chart 2.2 Contribution to headline inflation

Per cent 8 7 6 5 4 3 2 1 0 -1 Q1 2005

Core inflation Energy

Raw food Headline inflation

Source: Trade and Economic Index Bureau, Ministry of Commerce

Inflation Report October 2008

2008 Aug 5.4 Aug 3.8 Jul 2.3

Aggregate demand in 2008 Q2

Chart 2.4 Real GDP growth at 1988 prices

Per cent 8 2005 = 4.5 6

2007 = 4.8 5.3

Source: National Economic and Social Development Board

Chart 2.5 Contribution to GDP growth

Per cent 14 12 10 8 6 4 2 0 -2 -4 -6 -8 Q1 2005

Public consumption Public investment Changes in inventory and statistical discrepancies

Source: National Economic and Social Development Board

Inflation Report October 2008

Per cent 6 4 2 0 -2 Q1 2005 Q1 2006 Q1 2007

Services Non-durables Semi-durables Durables PCE

Source: National Economic and Social Development Board

Per cent 15 10 5 0 -5 Q1 2005 Q1 2006

Source: National Economic and Social Development Board

Inflation Report October 2008

Trend of aggregate demand in 2008 Q3

Index 100 Private consumption growth (RHS)

Annual percentage change 6 Consumer confidence index

40 Q1 2005 Q1 2006 Q1 2007 Q1 2008

Index 50 Private investment growth (RHS) 45

Annual percentage change 15 Business sentiment index 10 40.7 5 4.3 0 -5

40 35 30 Q1 2005 Q1 2006 Q1 2007 Q1 2008

Inflation Report October 2008

Current account balance

Production and supply in 2008 Q2

Inflation Report October 2008

Chart 2.11 Contribution to GDP growth

Per cent 8 Agriculture 6 4 2 0 -2 Q1 2005

Source: National Economic and Social Development Board

Trend in production and supply in 2008 Q3

Inflation Report October 2008

Chart 2.12 Contribution to manufacturing production index (MPI) growth

Per cent 16 14 12 10 8 6 4 2 0 -2 Q1 2005