EDITORIAL

BOT turns hawkish to deflate threat of growth bubble

By The Nation

Risk of excessive growth in real estate sector prompted interest rate hike

The Bank of Thailand on Wednesday hiked its short-term interest rate by 25 basis points to 2 per cent. This is a welcome and prudent move, although most economists and analysts expected the BOT to stand pat given the benign inflation and a slower pace of economic growth going forward. The inflation rate for November was 2.8 per cent. But the Monetary Policy Committee has found it necessary to nip bubbles, particularly in the real estate sector, before they get out of control.

Indeed, the central bank needs to bring the interest rate back to its normal level. This means that on the inflation adjusted basis, the interest rate must pose positive rather than negative, as is now the case. At least the policy rate of the central bank should hover around 3 per cent to match the expected rate of 3 per cent in interest rates this year.

The Bank of Thailand under Dr Prasarn Trairatvorakul must stick to its mandate of safeguarding price stability. In the previous Monetary Policy Committee's meeting, the central bank bowed to pressure by keeping the interest rate unchanged at 1.75 per cent. The prevailing mood then was that the rate must be maintained or even slashed to discourage institutional investors from pouring their hot money into the Thai bond and equity market. Higher interest rates would entice the institutional investors to bring even more funds into the Thai market to speculate on the interest rate differentials. Yields of Thai bonds are at least two percentage points higher than yields of US bonds of similar maturity. Since the beginning of this year, capital inflow has driven the baht value by 10-11 per cent, turning the baht into one of the world's best performing currencies.

By keeping its rate unchanged at the Monetary Policy Committee's meeting, the central bank showed its hesitancy over its mandate. For if capital inflow were the real problem that added to price pressure and financial bubbles, the central bank should have dealt with it with separate administrative measures. This means the central bank could impose higher withholding tax or currency controls to stem the tide of the hot money inflow.

Now the central bank has become more hawkish. In monetary policy, it is always prudent to stay hawkish rather than dovish. Thai interest rates have been kept too low for an extended period to stimulate the economy. This has resulted in bubbles in both the stock market and real estate. The situation has been accentuated with capital inflow, driven by quantitative easing measures by the major world's central banks.

Naturally, businesses and investors love the low interest rate environment, which spurs growth and prosperity. But we have to take note from the dear lessons from many countries, which are now facing severe financial crisis. Low interest rate environment is the source of economic and financial bubbles. Greece, Ireland, the United States enjoyed the low interest rate environment, over-spending, easy loans and a boom in real estate before the bubbles went burst. Many other European countries are about to follow suit.

In spite of the slowing down Thai economy, the central bank should be determined with its monetary policy. The interest rate normalisation process must continue so that interest rates must at least match or beat the inflation rate.

-- The Nation 2010-12-06

If the BoT is looking to reach a parity level of 3% interest then perhaps a 25 basis point move was a bit conservative? You can read my musings on the baht here.

News to me that there is a bubble beginning to form in the real estate market...of course I'm always the last one to find out. I can be wrong (I'm experienced at that) but it seems the residential market is basically flat (price-wise) and seems to be a lot of price reductions in the Bangkok area based on advertisements for middle class Thai homes. And some farang home type areas are downright hurting since these type homes are usually in the higher price range. Don't know about the commercial real estate market.

Up interest to kill the poor people who borrow. Please the rich who deposit.