We believe continued political risk and a deteriorating economic backdrop are likely to weigh on Thai assets.
We believe continued political risk and a deteriorating economic backdrop are likely to weigh on Thai assets. While the baht should hold up better than others in EM, the poor growth outlook will likely weigh heavily on Thai equities. Thailand is also very vulnerable to the El Nino effect, with drought conditions already developing in the country.
The political situation is stable, but remains unsettled. The potential for future conflict is still there. The military has held power since May 2014, and has given little indication as to when democracy will be restored. An original timeline of an interim government until September 2015, followed by a new constitution and fresh elections in late 2015, will not be met. The junta is now saying that a popular referendum on the new constitution will be held, which in turn will delay elections until August 2016 at the earliest.
Social tensions between the various factions remain in play, simmering below the surface despite the military-imposed calm. Former Prime Minister Thaksin remains in exile. The ruling junta has calmed the situation by suppressing protests and dissent, but the fundamental divide between the Yellow Shirts (anti-Thaksin) and the Red Shirts (pro-Thaksin) has not been addressed. Thailand is simply one of many polarized countries in the world, with little to suggest it will be reversed anytime soon.
On top of the political uncertainty, it appears that a potentially messy royal succession is shaping up. King Bhumibol has ruled since 1946 but he is ailing at 87 years. He recently returned to a hospital after a seven month stay ended in May. According to the current constitution, King Bhumibol’s only son, Crown Prince Vajiralongkorn, would succeed him, but he is deeply unpopular. Some analysts have suggested that the military does not want to relinquish power until after King Bhumibol’s death, given the risks of a power struggle and civil unrest then.
For now, the military identified its main priority is to boost economic growth. Policymakers continue to struggle, however. The economy was already under pressure, but now the El Nino effect is coming into play and it is shaping up to be very negative for Thailand. Bank of Thailand Governor Prasarn said that the current drought presents “downside risk” to its 3% growth forecast for 2015, as the BOT hasn’t factored the drought into its current outlook. BOT officials estimate that the drought could shave 0.1-0.5 percentage points off growth.
For Thailand, the IMF expects 2015 and 2016 GDP growth of 3.7% and 4.1%, respectively. This comes after 0.9% in 2014. GDP rose 3.0% y/y in Q1, but this was boosted by very low base effects. The y/y growth rates should ease over the next couple of quarters as the low base wears off.
Complicating matters for the BOT will be the likely spike in food prices. Taken in tandem with low base effects from last year, CPI is facing upside risks. As such, the call to cut rates is not as clear-cut as one would hope. The BOT now targets CPI for 2015 at 2.5%, but within a tolerance band of 1-4%. Inflation stood at -1.1% y/y in June, which was the sixth straight month of outright deflation. The BOT last cut rates 25 bp to 1.5% in April. While officials have downplayed the likelihood of further cuts, we look for more easing in H2.
Fiscal stimulus is already being seen via increased public investment. The budget deficit remains manageable, giving policymakers leeway to pull some fiscal levers. The overall gap is expected to remain around -2% of GDP this year, very close to what was seen in 2013 and 2014.
The external accounts are in good shape, but due mostly to weaker imports. We believe ongoing political problems have negatively impacted foreign investment. However, the current account has moved into surplus, likely to come in above 4% of GDP in 2015 vs. 3.3% in 2014. As such, Thailand’s vulnerability to hot money flows has decreased.
USD/THB made a new high for the cycle, and is at the highest level since 2009. Charts point to a test of the March 2009 high near 36.44. We think that as long as the pace is measured and comes within the context of a broadly stronger dollar, Thai policymakers will not try to fight baht weakness. We note that our EM FX model suggests THB will outperform within EM over the next three months. THB has been one of the outperformers so far in 2015, -3.7% vs. USD. The worst performers at BRL (-15.3% YTD), COP (-12.7% YTD), and TRY (-12% YTD).
Thai equities are performing similarly to the wider EM. MSCI Thailand is -1.7% YTD, which is the same performance for MSCI EM. Our EM equity model suggests Thailand will underperform within EM over the next three months. This is down from a neutral reading for the previous quarter, and reflects a deteriorating growth outlook. Foreign investment in the Thai equity market is down nearly $1 bln YTD, one of the only markets in Asia to see an outflow this year.
Thai local currency government bonds have outperformed over the last six months. 10-year yield has risen 17 bp, while the worst EM performers over the same period include Peru (up 108 bp), Czech Republic (up 83 bp), and Indonesia (up 77 bp). We think that the BOT easing cycle and a deflationary environment have been factors behind this outperformance, which could be put to the test if inflation spikes as we expect.