On July 16, The Bank of Thailand (BOT) hiked its benchmark interest rate by quarter of a percentage point to 3.5%, the first rise in two years. Further hikes are expected if the move does not have the intended effect of heading off inflation, which rose to 8.9% in June, at its highest level for a decade.
BOT's bi-annual monetary policy statement said that inflation risks had "increased markedly" over the second quarter of 2008, adding that price rises risked undermining Thailand's economic fundamentals and the government's growth-oriented policy.
The markets' immediate reaction to the rate rise was negative, with the baht losing 0.1% to 33.51 against the dollar while the SET, Thailand's benchmark stock index, fell 3.4%. Both currency and capital market have already taken a hit this year, the baht dropping 11.7% against the dollar and the SET falling 24% since January, due to a global retreat from stock exchanges, a degree of uncertainty regarding the new government and soaring inflation.
However, while the immediate effect of the rate rise saw increased losses, the consensus among business leaders, surveyed in the media, seems to be that the BOT has timed the move correctly.
"For the sake of the economy's long-term prospects, it's better to focus on high inflation now rather than weakening growth," Robert Subbaraman, chief economist at financial services firm Lehman Brothers Asia told the international press. "It will be even worse if inflation gets out of control."
Pornthep Jubandhu, an economist at SCB Securities in Bangkok agreed, saying "the central bank has no choice".
An International Monetary Fund (IMF) report on Thailand published on June 18 had recommended that BOT monitor the monetary policy stance on an ongoing basis and stand ready to adjust it, in response to the domestic inflation outlook. With inflation hitting a 10-year high last month, a rate increase is in line with the Fund's advice.
The increase may help rein in inflation while bolstering confidence in Thailand's macroeconomic management. By July 18, the baht had edged up to THB33.32 to the dollar, gaining 0.6% on the day, perhaps indicating a cautious market welcome for the central bank's move. Thailand and other South East Asian countries are wary of loss of confidence in their currencies and capital markets. The 1997 economic crisis, which saw significant capital flight from the region, is still a painful recent memory.
While the BOT has demonstrated its willingness to tighten monetary policy when necessary, the government has proposed a $1.4bn package of targeted tax cuts and social payments. The package is in keeping with the government's mandate to boost growth and tackle poverty. With Thailand's growth rate expected to top 5% this year and next, there is plenty to be positive about, and there is every sign that the BOT will continue exercising caution in its monetary policy.