Chart 1: Taiwan 2Q GDP up by 20.7% q-o-q annualised!

Chart 2

Chart 3

Chart 4

Chart 5

Chart 6 Chart 7

Asian countries hoisted their sails and rode with the wind as they navigated their economies out of the recession, growing at a much faster and stronger pace than other regions. Among these economies, Thailand has surprised the market as they managed a rapid recovery (refer to chart 1) despite being plagued by ongoing political differences that has only recently resulted in one of the most violent protests in Thailand’s modern age history.

Thailand’s equity market, measured by the SET Index has also performed well year-to-date, returning 12.7% (as of 14 July 2010, in SGD terms), after reaching a new high for the year on 9 July 2010. The Thailand Baht (THB) has also performed favorably against major currencies, appreciating 3.2% against USD, 16.1% against EUR and 9.4% against GBP (year-to-date as of 14 July 2010).

On the back of such a strong economic climate, the Bank of Thailand (BoT) decided to hop onto the rate raising bandwagon and hike the benchmark interest rate by 25 basis points (bps) to 1.5% on 14 July 2010, following the scheduled Monetary Policy Committee (MPC) meeting.

exports benefitting from recovering global demand

Thailand has traditionally been a net exporter (refer to chart 2) although there are times when imports outweighs exports, resulting in momentary negative trade balances. However, both exports and imports have been rising steadily since falling to a recent low in April 2009. Trade balances remained in the positive zone most of the time as the Thai economy benefited from recovering global demand, which in turn lifted GDP growth. May 2010 figures show that current exports level is almost on par with pre-crisis levels and we believe it will likely make new highs this year.

heavy dependence on external demand

Using the average quarterly GDP data over the last three years (2007 to 2010), the key contributor of GDP appears to come from domestic consumption, which amounts to almost half of the nation’s GDP. However, even though net exports amount to 16.5% of GDP, Thailand is still heavily dependent on external demand. The value of exports out of Thailand is about 70% of the nation’s GDP (refer to chart 3) while value of imports from overseas is about 53% of the nation’s GDP.

The key trading partners for Thailand are mainly from Asia, which made up more than half of Thailand’s total exports, particularly the ASEAN region which takes up almost 30% of total exports (refer to chart 4). Still, a substantial amount of Thailand’s export is dependent on the developed nations such as US, Europe and Japan; each takes up about 10% of the total exports. However, the importance of these developed nations seems to be waning as exports to these regions have been declining steadily over the past few years. The share of exports has shifted to Asia, whose impressive growth this year should continue to support Thailand’s economy moving ahead.

rising confidence despite political tension

Confidence levels do not appear to be heavily dampened by political tensions in Thailand as indicators measuring sentiment continue to rise (refer to chart 5). Although consumer confidence may appear muted, business sentiments are significantly higher than during the recession. Consumption has also rebounded strongly, surpassing pre-crisis levels. The rising sentiments are in line with Thailand’s economic leading indicator which is pointing in the direction of growth.

We expect these sentiment indicators to trend higher in the later half of the year though we do not eliminate the possibility of a return of the anti-government protests which will then have an adverse impact on sentiments once more. May’s conclusion was merely a temporary resolution that has not addressed the root of the problem which the protest originated from. We are therefore awaiting PM Abhisit’s government to release their finalized reconciliation plan which is currently still in the works.

inflationary pressure an unwelcomed return

Like an unwelcomed guest, inflation will return uninvited, especially if the economy continues its present rate of growth. In June, the CPI index gained 3.3% year-on-year after gaining 3.5% year-on-year in May. While inflation at the current rate may be regarded as benign (coming off a lower base in 2009), it has already surpassed the 10 year average inflation rate of 2.5% (refer to chart 6). The gradient of the CPI year-on-year curve suggests an accelerating pace of rising inflation. We therefore believe that it may be prudent for the central government be ahead of inflation and should hasten their interest rate normalization process before things start to get out of hand.

mpc raised benchmark interest rates

Following the Monetary Policy Committee (MPC) Meeting scheduled on 14 July 2010, BoT raised the benchmark interest rate for the first time in almost two years. The benchmark interest rate was increased by 25 bps, to 1.5%. According to the MPC, the impact of domestic political situation on the Thai economy in 2Q 2010 has proved to be limited as Thailand recorded strong economic growth in 1H 2010. BoT also expects favorable growth in 2H 2010 as well. While inflation remains modest, the central bank believes inflationary pressure will return next year, in line with robust economic expansion. As such, it sees a lesser need to maintain an exceptionally accommodative monetary policy.

The 25 bps hike appears to be a conservative hike (refer to chart 7) as even at 1.5%, the interest rate remains accommodative and therefore should continue to support growth. However, it is unusual for the MPC to hike or slash rates by a margin larger than 25 bps (only 9 occurrences over the last 10 years). Therefore, we believe that it is likely that the MPC will continue to increase interest rates gradually over the next few scheduled meetings. Should inflationary pressure accelerate further, we may see the MPC raising rates by more than 25 bps.

Conclusion

Although Thailand equity has recently risen to new highs for the year, the SET index is trading as a forward PE ratio of 11.7X and 10.0X based on 2010 and 2011 estimated earnings respectively as of 14 July 2010. At this level, valuations remain undemanding. Coupled with the strong economic conditions, Thailand equity market should continue to draw strong buying interest, driving the index level even higher.

However, given the large dependency on foreign markets and the lingering debt problems in Europe, we prefer to exercise prudence in our exposure to Thailand in preparation for any downside surprises. We therefore advise investors to limit Thailand equity exposure to their supplementary portfolios.

For investors who are already invested in Thailand, they should to review their portfolio and rebalance where necessary to avoid being overexposed to Thailand and also to cash in some of their profits. As for investors who are planning to enter the market, they should avoid taking a concentrated position and can consider spreading out their entry point so as to avoid buying only at a new market high.