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Thailand could yet escape a recession; Citi Group report

Economy's vulnerable to shocks, but could yet escape a recession

BANGKOK: -- Thai growth faces a downgrade due to US recession and domestic political risks, CitiGroup Global Markets reports

Recent political developments reinforce the downside risk to growth arising from heightened US recession risk. Political uncertainty that will not likely be resolved soon is likely to constrain fiscal spending.

This increases the vulnerability of the broad economy to US recession shocks. Limited spark from fiscal spending that may not make up for the expected slackening in net exports underpins our GDP downgrade to 4 per cent in 2008 and 1 per cent in 2009. Nonetheless, we think upside risk governs our new base case. A sharp increase in fiscal spending as political distractions ease would be favourable in second half of 2009.

We don't expect the local economy to fall into a recession or record two straight quarters of GDP declines, but with 1 per cent growth, the country is close to a recession.

On a year-on-year comparison, GDP prospects in 2009 would suffer by comparison with growth exceeding 5 per cent year on year in the first half of 2008. As such, we don't expect a marginal GDP decline in the first half of 2009, but we do expect a modest recovery in the second half of next year. Net exports are likely to drop in the first half next year with real exports pacing the decline. On a quarterly comparison, our seasonally adjusted GDP estimates are an incremental decline of 0.3 per cent quarter on quarter in the first quarter of 2009 and a marginal gain of 0.3 per cent quarter on quarter in the second quarter of 2009.

We expect US recession risk and global contagion effects to cut the contribution of net exports to GDP from an estimated 16 per cent in 2008 to 14.7 per cent in 2009. Manufactured exports, which account for 90 per cent of total exports, would suffer from lacklustre demand by key trading partners. Moreover, in the first half of 2008, upbeat export momentum was not broad-based, but a few industries such as canned seafood, pineapple, compressors and integrated circuits posted upbeat volume growth.

The decline in net exports would have been deeper and a recession likely next year if we assume imports won't decline as well. Easing exports would also mean fewer imports of raw materials. Sluggish domestic demand prospects with private spending likely to decline would restrain non-oil import demand.

A period of sustained lacklustre fiscal spending that started in the first half of 2008 would probably continue in the second half. We assume that the political situation would be resolved within this time frame. In the meantime, private spending would probably drift lower without a fiscal spending catalyst. With offshore and onshore markets likely gripped by risk aversion, we expect more cautious consumer and business sentiment as:

1 Declining exports raise the risk of jobs being shed in the manufacturing export sector

2 Falling commodity prices would also mean less lift for farm incomes

3 Residential real-estate speculation may ease if public investment activity continues to be constrained by political problems.

Durable goods spending that accounts for close to 10 per cent of real personal consumption would contribute to the upside or downside risk to our domestic demand scenario. Spending has continued to surprise on the upside as it rose 10.7 per cent in the first half of 2008 despite inflation shocks. Over July-August, passenger car sales and motorcycle sales remained upbeat in double-digit terms even though they decelerated.

We think the favourable monetary backdrop during a period of negative real interest rates supported durable goods spending. Price terms of trade that benefited farm incomes and access to credit in the first half of 2008 were additional factors that boosted durable goods demand.

However, the real interest rate advantage may erode with inflation's downcycle.

The local equity market's collapse (SET down 384 points or -45 per cent) coinciding with the global financial crisis in September would probably enhance the negative wealth effect and spur cautious spending among the middle and upper classes. We don't expect strong risk-taking activity such as increased capex and substantial real-estate project expansion given the strong risk aversion and unexciting onshore and offshore market conditions.

Tourism prospects would directly impact hotel and restaurant services and retail trade.

Tourism arrivals registered an incremental gain of 0.2 per cent year on year in August, down from 9.6 per cent year on year in July, as local politics heated up in the third quarter.

Amid the global financial gloom and recessionary environment, we don't expect tourism to provide a strong economic lift, particularly due to the political situation. In the second quarter, hotel and restaurant services (8.2 per cent of private domestic consumption) registered average growth of 5.2 per cent year on year, down from 8.3 per cent year on year in the first quarter.

A delayed contribution of fiscal expenditures to growth may prompt the monetary authorities to act in order to firm up the downside risk to growth. The inflation downturn that may retrace official targets more quickly than expected offers an excellent opportunity for policymakers to cut rates early in 2009 and spur durable goods spending.

We anticipate at least 100bps of rate cuts in 2009 as policy-makers shift their emphasis to fending off downside risk to growth from averting inflation risk. In our sensitivity test, a rate cut impact in early 2009 would impact 2009 when the environment of risk aversion would be less threatening to sentiment and spending.

-- The nation 2008-10-22