No. 51/2010

Inflation Report October 2010

Mr. Paiboon Kittisrikangwan, Assistant Governor, Bank of Thailand (BOT), announced that the Monetary Policy Committee (MPC) released the October 2010 issue of the Inflation Report on 28 October 2010. The Report was issued to enhance public understanding of the BOT’s policy stance, with the key details summarized as follows.

Recent developments in inflation and economic conditions

In 2010 Q2, the Thai economy continued to register strong growth mainly driven by merchandise exports and private spending, despite decelerating somewhat due to the effect of the political unrest. Latest indicators in the first two months of 2010 Q3 pointed to robust year-on-year growth of private spending, though the pace moderated from the preceding quarter due to a slowdown in the volume of merchandise exports in line with external demand conditions, and as reflected also in the easing of manufacturing output in several sectors.

With respect to inflationary pressure in 2010 Q3, core inflation picked up mainly due to the base effect coming from the disappearance of the negative contribution from the free-of-charge education program. Meanwhile, headline inflation remained close to the previous quarter, as the upswing in core inflation and raw food prices due to unfavorable climate conditions were roughly offset by the reduction in pressure from domestic retail oil prices due to the high base in the preceding year.

Economic growth and inflation projections

In forming economic and inflation forecasts for the next eight quarters, the MPC revised the key assumptions from those used three months earlier as follows:

1. The demand for Thai exports is revised up in 2010 following stronger-than-expected growth in Asia and Europe, before reverting back to the previous trend in 2011.

2. The Fed funds rate is expected to rise in 2011 Q3, later than previously assumed, as the recovery of the US economy remains fragile and may be more protracted than assessed previously.

3. Regional currencies are assumed to appreciate more against the US dollar, as growth prospects of regional economies remains strong compared to those of industrial countries. Moreover, the recent slowdown of the US economy has boosted capital flows into the region.

4. Direct government spending assumption for fiscal year 2010 is revised down following state-owned enterprises’ delayed disbursement, despite the fact that a decline in government transfer would leave a larger share of the budget for government consumption. For fiscal year 2011, government spending is expected to rise slightly due to the upward revision of consumption disbursement in accordance with the government’s disbursement target. The latter is partially offset by the

2

downward revision in investment spending to follow state-owned enterprises’ investment budget as approved by the Cabinet on 21 September 2010.

5. The Dubai oil price assumption is lowered from that in the previous Report. Although the fundamentals underpinning oil prices remains largely unchanged, the fragility of the US economic recovery and the lower-than-expected outturn in 2010 Q3 point towards a slower uptrend, with the oil price averaging at 77.0 and 86.3 US dollar per barrel in 2010 and 2011, respectively.

6. Agricultural prices are revised up throughout the projection period following higher-than-anticipated outturns in 2010 Q3 due to adverse climate conditions, especially for vegetables and fruits as well as eggs and dairy products. Climate factors also underpinned an upward shift in non-fuel commodity prices in 2010 compared to the previous assumption mainly due to rising price of food and beverages, before subsiding in 2011 in line with the IMF’s forecasts of a significant drop in the price of agricultural raw materials and beverages from the preceding year.

7. The minimum wage assumption remains unchanged at 206 baht per day in 2010 before rising to 213 baht per day in 2011, in tandem with the economic recovery and higher inflation going forward.

Under the above assumptions and conditioning on the domestic policy interest rate remaining at the present level of 1.75 per cent per annum over the next 8 quarters, the MPC projects the Thai economy in 2010 to grow at a pace stronger than that in the previous Report, mostly owing to the higher-than-expected growth of exports and private spending in the second quarter. This is in despite of a softening of merchandise exports in the third quarter following the sharp pick-up in the first half of the year in line with the global recovery. From the second half of 2010 onwards, private spending would become the main driving force of the Thai economy.

Although some upward price pressure will result from continued economic growth, the MPC expects core inflation in 2010 to remain close to the previous projection, as firms’ ability to raise prices would be limited by high competition. Headline inflation will edge up due to the higher-than-expected acceleration of raw food prices in the third quarter, and then continue on an upward trend in the fourth quarter due to adverse climate conditions affecting agricultural supply. While cost pressure is expected to subside in line with developments in oil and raw materials prices, this would not be sufficient to offset the upward pressure coming from raw food prices. In 2011, the MPC projects core inflation to pick up from the preceding year in line with the upward revision of the minimum wage assumption, demand pressure from the economic growth, and the narrowing output gap which would induce greater pass-through of rising production costs to retail prices. Headline inflation is expected to increase as well, following core inflation and rising agricultural prices. In addition, the termination of the government’s cost-of-living subsidy measures would also contribute positively to inflation.

The MPC took note of risk factors that might cause the economy to deviate from the baseline projection. On the whole, the MPC judged that downside risks to growth would outweigh upside risks throughout the projection period. Major risk factors come from the external front, in the form of uncertainties regarding global growth prospects and the volatility of capital flows across countries. Reflecting these risks, the fan chart for economic growth is skewed downwards throughout the projection horizon, resulting in a projection for economic growth in the ranges of 7.3-8.0 per cent in 2010 and 3.0-5.0 per cent in 2011.

In terms of the inflation projection, the MPC saw upside risks outweighing downside ones from 2010 onwards. Accordingly, the fan charts for both core and headline inflation are skewed upwards at the end of the projection period. The MPC projects headline inflation to average within the ranges of 2.8-3.8 per cent in 2010 and 3.0-5.0 in 2011. Core inflation, on the

3 other hand, was expected to be within the ranges of 0.5-1.3 per cent in 2010 and 2.0-3.0 per cent in 2011.

Monetary policy stance in the last 3 months In the meeting on 25 August 2010, the MPC assessed that the Thai economy continued

to expand even in the face of the political unrest. Meanwhile, inflationary pressure was expected to rise in 2011 with a small possibility that core inflation could rise above the upper band of the target range. The MPC therefore raised the policy interest rate by 0.25 per cent per annum, from 1.50 to 1.75 per cent per annum. In the following meeting on 20 October 2010, the MPC expected a continued growth momentum driven by private domestic demand, with some downside risks due to the slowdown of the global economy potentially affecting the export sector. At the same time, inflationary pressure remained stable from the previous quarter. In the context of ongoing interest rate normalization, increased uncertainty with respect to the global economic recovery, as well as heightened risks in the global economy and financial markets, the MPC deemed it necessary to assess these factors and their impact on the Thai economy more carefully, and thus decided to keep the policy interest rate at 1.75 per cent per annum.

Bank of Thailand 28 October 2010

For further information: Kritchaya Janjaroen Tel. 0 2356 7876 e-mail: kritchap@bot.or.th