Recent Developments and Near-Term Outlook

2. The Thai economy has been on a gradual recovery path since the beginning of 2015 as private sector confidence is restored. In the first quarter of this year, the economy grew by 3.2 percent, driven mainly by government spending and broad-based increase in the number of inbound tourists. This outcome is in line with the authorities’ growth projection of slightly above 3 percent for the year 2016.

3. The authorities concur that risks to the economic outlook are tilted to the downside from both external and domestic fronts, including weak global growth prospects, China’s engineered slowdown due to the structural rebalancing, changes in global trade structure, plummeting commodity prices, as well as the drought’s impact on the income of agricultural households. In addition, implementation and communication of monetary policy in major economies may continue to be a key contributing factor to capital flow and exchange rate volatility.

4. Despite significant uncertainties and headwinds, Thailand is able to maintain overall economic stability and sound fundamentals, supported by a strong external position, robust banking system and flexible exchange rate. Nevertheless, recent global economic and financial conditions do not warrant complacency and the authorities are closely monitoring global developments and preparing policy toolkits in order to appropriately counter unexpected shocks.

Macroeconomic Policy Response

5. On fiscal policy, the authorities view that public spending will continue to play a crucial role in driving growth in 2016 and beyond, in particular, investment expenditure that will help crowd-in private investments given its larger scale compared to last year. With steadfast resolution to get the economy back on sustainable growth path, the government is committed to pressing ahead with the implementation of key infrastructure projects. The expedition of the water resources management and road transportation system projects has resulted in satisfactory expansion of public investment at 12.4 percent in the first quarter of this year, following a 41.2 percent growth in the fourth quarter of 2015. Against this backdrop, the authorities are optimistic that investment plan execution will progress at a higher rate compared to historical average and staff’s assumption, and believe that it will contribute to shoring up private confidence and market sentiment.

6. The Ministry of Finance has placed high priority on expediting the enactment of the Fiscal Responsibility Act to enhance public finance management, especially on fiscal prudence and transparency. The draft Act has been approved by the Cabinet in March 2016 and submitted for consideration of the Council of State. The ongoing reforms of State Owned Enterprises (SOEs) together with the establishment of a Holding Company for SOEs, would enhance their governance and transparency, and also contribute to efficient implementation of government projects in the future. The authorities are encouraged by staff’s public debt sustainability analysis which suggests that Thailand’s public debt would remain on a sustainable path in the medium term despite various shock scenarios.

7. On monetary policy, the authorities have maintained an accommodative stance to provide favorable liquidity and credit conditions in order to complement expansionary fiscal policy in supporting domestic demand, while preserving financial stability. The authorities take note of staff’s concerns over risk of deflation associated with negative headline inflation and falling inflation expectations in 2015, but view staff’s assessment as too pessimistic. The development of headline inflation (in terms of y-o-y percentage change) in Thailand is rather country-specific to the extent that it is more sensitive to global oil price movements due to smaller tax cushion in retail fuel prices, in comparison to other oil importing countries. As such, the latest figures already show headline inflation returning to positive territory in April 2016 as the impact of base effect of high oil prices from past periods dissipates. Meanwhile, the latest medium-term consensus forecast for headline inflation (April 2016) stands close to the inflation target at 2.5 percent, suggesting that medium-term inflation expectations remain relatively well anchored. The authorities anticipate that headline inflation will gradually rise in 2016 and 2017 as a result of continued positive base effect and gradual closing of output gap, albeit remaining subject to the uncertain outturn of global oil price movements and domestic demand recovery.

8. The authorities stress the importance of preserving policy space in light of potential policy spillovers of major economies and the bouts of volatility in the period ahead. Although staff’s simplified-model simulation of aggressive monetary policy easing (assuming 150 bps policy rate cut to zero percent) suggests that it might help prevent a downward spiral of inflation expectations, further easing needs to sufficiently take into account the effectiveness of monetary policy transmission under the low interest environment, and more importantly, the potential side effects on search-for-yield behavior and financial stability. The Monetary Policy Committee will remain vigilant on macroeconomic and financial developments, and stand ready to make use of available policy space should significant risks materialize.

9. Thailand has witnessed capital flows and financial market volatilities in recent periods driven by policy divergence of major central banks and the foreign investors’ search-for-yield behavior. In this regard, the flexible exchange rate has helped act as a shock absorber for the economy. The Bank of Thailand (BOT) also occasionally uses foreign exchange intervention to mitigate excessive exchange rate volatility so as to prevent its adverse effect on domestic financial conditions. In addition, the BOT announced additional measures earlier this year to relax foreign exchange regulations under the Capital Account Liberalization Master Plan aimed at deepening Thailand’s financial markets and encouraging outward investment by residents to balance capital flow movements.

Financial Sector Stability

10. We are encouraged by staff’s acknowledgement that Thailand’s financial system remains resilient amidst volatility in global financial markets and welcome in-depth assessment of macro-financial stability. The banking sector, the key financial intermediary, has been performing well with comfortable level of capital buffers, liquidity and profitability ratios. Notwithstanding, the authorities acknowledge that there are pockets of vulnerabilities among Specialized Financial Institutions (SFIs) and less regulated intermediaries such as saving/credit cooperatives and non-bank financial institutions whose exposure to commercial banks have increased over the years.

11. In line with staff’s recommendation, the authorities give high priority to continue strengthening supervision and oversight of SFIs, most of which are financially healthy. The transfer of supervisory authority over SFIs to the BOT is expected to be completed by the end of this year to ensure that SFIs would remain financially sound, while effectively fulfilling their mandates. The BOT is working on the necessary preparation to carry out both on-site and off-site examinations of SFIs for compliance with its regulations and risk management standards.

12. Exposure of cooperatives to commercial banks may have noticeably increased but remains small in absolute terms. Deterioration in their financial standings is thus likely to be contained, with limited spillovers to the overall banking sector. Nevertheless, given that potential implications for retail stakeholders remain, the supervisory agency has been in close consultation with the BOT on appropriate application of banking standards on savings cooperatives, and cooperatives’ participation in the national credit bureau database to improve credit analysis and enhance risk monitoring.

13. The issue of high household debt still lingers, partly as a result of deteriorating debt-service capabilities of agricultural and low-income households. The authorities share staff’s concern that the debt overhang could weigh down consumption and in turn, hinder economic recovery. Nonetheless, recent figures suggest that household debt has somewhat leveled-off following the application of more stringent credit standards and as the legacy from government’s consumption stimulus measures subsided. To address debt overhang, the authorities are working on policy measures to facilitate banks in the process of household debt restructuring.

14. The authorities note staff’s recommendation to tighten the macroprudential policies, but consider that the various measures currently in place are sufficient at this juncture. Available policies in the current toolkit are not only in the form of regulations (e.g. LTVs, loan-loss provisioning, specific risk weights, capital surcharges, etc.), but also by means of moral suasion which have proven effective so far. The authorities are of the view that further tightening would require caution in light of sluggish growth. The degree of adjustment and timing of implementation are also critical to achieve the desired outcome without unintended consequences. To prepare for possible risks to financial stability, the authorities are undertaking study on new measures such as Debt-to-Income Ratio, and stepping up efforts to enhance data quality as well as risk monitoring tools to improve effectiveness of macroprudential policy implementation. In this respect, the authorities would like to express appreciation for the Fund’s technical assistance in strengthening Thailand’s financial stability framework.

Structural Reforms

15. The authorities recognize that structural issues will have an important bearing on the economy in the long-run. A number of reform policies and measures are underway to facilitate structural adjustment in the period ahead by promoting high value-added industries, transforming to digital economy, as well as deepening regional integration to strengthen the country’s competitiveness. To achieve such objective, a number of infrastructure upgrade projects will facilitate a more effective transfer of factors of production both within the country and to neighboring countries. This plays to Thailand’s geographical advantage of being located at the heart of the ASEAN economic community. The authorities have taken steps to improve the ease of doing business in Thailand and collaborated with the private sector to streamline business incorporation process, reduce red tape and documentation requirements.

16. Regarding developments in regional integration, Thailand continues to benefit from the ASEAN Economic Community (AEC) and participation in other trade partnerships is also being considered. Within ASEAN, the fast-growing CLMV countries have become Thailand’s important trading partners. Their robust growth performances despite the global slowdown would contribute to Thailand’s economic recovery in the period ahead. As pointed out by staff, the Trans-Pacific Partnership (TPP) could have important implications on the global trade structure going forward. Thai authorities are now studying the costs and benefits of TPP, and have been in consultation with national stakeholders to thoroughly evaluate opportunities from as well as the economic and social implications of joining the agreement. In addition, the authorities are working on other trade partnerships such as the Regional Comprehensive Economic Partnership (RCEP) between ASEAN and six key regional economies.

17. The authorities are aware that aging population could have important implications not only on labor productivity, but also on adequacy of social safety nets and pose contingent fiscal burden. On staff’s recommendation for a more open policy toward foreign workers, the authorities view that labor policy has been adequately flexible in addressing labor shortages and priority has been given to policies for improving migration management to solve the illegal workers problem and limit their impact on public health expenditure. To tackle this important issue in a holistic and sustainable manner, the authorities continue their efforts on upgrading labor skills in collaboration with the private sector, reforming the education system, and promoting the use of technology to increase productivity.

18. On fiscal consequences of population aging, the authorities are initiating the work on pension system reforms. The Ministry of Finance has set up a committee to undertake this task although details have yet to be released at this early stage. The authorities also aim to enhance individual savings through National Savings Fund that will cover 25 million people aged between 15-60 years in the informal sector so as to encourage accumulation of savings for retirement.

Final Remarks

19. The authorities believe that the Thai economy’s strong fundamentals and resilience will provide solid foundation to meet the future challenges, while the country’s long-term potential and competitiveness will be enhanced by the steadfast implementation of much needed reforms, many of which would foster sustainable private investment. The authorities look forward to continued support by the Fund through invaluable technical assistance in their reform endeavors.