Thailand 4.0 ( and the IMF Article IV)

Thailand 4.0 ( and the IMF Article IV) Ana Corbacho IMF Mission Chief for Thailand September 25, 2017 Tokyo Thailand 4.0 Government s vision Transform Thailand into a value-added and innovation-driven economy from commodities to innovative products; from production-based to service-based; by creating an environment for investment and growth into the future But relying on some old ways: target industries; tax incentives

Context Cyclically-weak emerging market Persistent (small) negative output gap Output Gap (Percent of potential GDP) 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0-1.5-2.0 2010 2011 2012 2013 2014 2015 2016 Source: IMF staff calculations. Inflation below target band Headline and Core CPI Inflation (Y/y percent change) 8 6 4 2 0-2 -4-6 Headline Old core target band Headline target band Core Headline mid-point target Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12 Dec-12 May-13 Oct-13 Mar-14 Aug-14 Jan-15 Jun-15 Nov-15 Apr-16 Sep-16 Feb-17 Sources: CEIC Data Co. Ltd.; and IMF staff calculations. that is saving too much, investing too little Political transition 2014: Military regime 2016: Royal Succession 2017: Constitution endorsed 2018: General elections

and faces long-term challenges today EUR US HGK PHL MYS IND IDN KOR JPN VTN CHN THA SGP Rapid Population Aging Years for the Old-Age Dependency Ratio to Increase from 15 to 20 Percent 0 10 20 40 50 60 Other AEs US CHN SGP HKG THA KOR JPN IND MYS PHL IDN VTN Slowdown in Productivity Decline in TFP Growth Since Global Financial Crisis (In percentage points) -1 0 1 2 3 4 Where is Thailand heading? Strong exports and tourism are supporting growth, but investment has been disappointing large infrastructure projects taking time Inflation is projected to undershoot the target band in 2017 and reach the lower end of the band (1 percent) only by end-2018 Excessive current account is expected to persist into the medium term Near-term growth is holding up, but downside risks dominate Global financial volatility A turn to inward-looking policies Hard landing in China Entrenched low inflation Household debt overhang Political uncertainty

Thailand Article IV IMF staff advice Avoid a low-inflation, low-growth trap through an expansionary policy mix and structural reforms: 1) Monetary policy easing and enhanced communication should steer inflation back to target 2) Macroprudential policy and regulatory reform can address emerging pockets of financial fragility 3) Existing fiscal space should be used to remove infrastructure bottlenecks within a sustainable, medium-term framework 4) Concerted reforms should foster inclusive and sustained growth Reduce the excessive current account through a growth-driven process, boosting real incomes 1) Monetary easing and enhanced communication to steer inflation back to target Trend inflation below target since 2015 Thailand: Trend Inflation (In percent) 4.0 3.5 3.0 2.5 2.0 Trend inflation 1/ Consensus Forecast (6-10 years) Inflation target (mid-point value) 1.5 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Sources: Consensus Forecast; and IMF staff calculations. 1/ Trend inflation estimates, from Garcia and Poon (forthcoming), are based on actual inflation dynamics and long-term survey inflation expectations, following Chan, J., Clark, T., and Koop, G., 2015, A New Model of Inflation, Trend Inflation, and Long-Run Inflation Expectations, FRB of Cleveland Working Paper No. 15-20. Inflation dynamics less forward-looking Thailand: Main Drivers of Inflation (In percent) 9 Trend inflation Persistence Economic slack (output gap) Import inflation 7 Oil price Residual Actual inflation 5 3 1-1 -3-5 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Sources: Thai authorities; and IMF staff calculations.

Monetary policy alone is not enough reinforce fiscal stimulus and expectations channel Policy Rate (Percent) 2.50 2.25 2.00 Fiscal + monetary stimulus Headline Inflation and Target Band (Percent) 5 4 1.75 1.50 3 1.25 2 1.00 0.75 No stimulus 1 0.50 0 2017Q1 2017Q2 2017Q3 2017Q4 2018Q1 2018Q2 2018Q3 2018Q4 2019Q1 2019Q2 2019Q3 2019Q4 2017Q1 2017Q2 2017Q3 2017Q4 2018Q1 2018Q2 2018Q3 2018Q4 2019Q1 2019Q2 2019Q3 2019Q4 2) Macroprudential policy and regulatory reform to address pockets of financial fragility Assessment of risks Financial stability risks contained Pockets of fragility High household debt legacy from past rapid credit growth Housing prices fast appreciation in Bangkok condominium area Regulatory arbitrage shift in risks to shadow banking Advice Monetary easing increases risks? Targeted action Time-varying MPMs for riskier households Tighter LTV; DTI for segments of real estate market Regulatory reform for consistent risk pricing across banks and nonbanks

2) Macroprudential policy and regulatory reform to address pockets of financial fragility Assessment of risks Financial stability risks contained Pockets of fragility High household debt legacy from past rapid credit growth Housing prices fast appreciation in Bangkok condominium area Regulatory arbitrage shift in risks to shadow banking Monetary easing increases risks? Advice Targeted Household Debt, action 1991-2016 (Percent of GDP) 90 MPMs for riskier households 80 Trend 1991-97 70 Tighter LTV; DTI for segments of Trend 2007-15 60 real estate market 50 Household Debt 40 Regulatory reform for consistent risk pricing across banks and 20 nonbanks 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Sources: Authorities' data; BIS; and IMF staff calculations. 2) Macroprudential policy and regulatory reform to address pockets of financial fragility Assessment of risks Financial stability risks contained Pockets of fragility High household debt legacy from past rapid credit growth Housing prices fast appreciation in Bangkok condominium area Regulatory arbitrage shift in risks to shadow banking Advice Thailand: Real House Price Indices (January Monetary 2009 = 100) 190 easing increases risks? 180 Single-detached house 1/ Targeted action 170 160 150 140 1 120 110 100 90 80 Condominium Time-varying MPMs for riskier Land households Tighter LTV; DTI for segments of real estate market Regulatory reform for consistent risk pricing across banks and nonbanks 2008 2009 Town house 1/ 2010 2011 Source: CEIC Data Co, Ltd. 1/ Including land. 2012 2013 2014 2015 2016 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17

2) Macroprudential policy and regulatory reform to address pockets of financial fragility Assessment of risks Financial stability risks contained Pockets of fragility High household debt legacy from past rapid credit growth Housing prices fast appreciation in Bangkok condominium area Regulatory arbitrage shift in risks to shadow banking Advice Thailand: Unrated Corporate Bonds Monetary easing increases risks? Targeted action Time-varying MPMs for riskier households Tighter LTV; DTI for segments of real estate market Regulatory reform for consistent risk pricing across banks and nonbanks 2) Macroprudential policy and regulatory reform to address pockets of financial fragility Assessment of risks Financial stability risks contained Pockets of fragility High household debt legacy from past rapid credit growth Housing prices fast appreciation in Bangkok condominium area Regulatory arbitrage shift in risks to shadow banking Advice Monetary easing increases risks? Targeted action Time-varying MPMs for riskier households Tighter LTV; DTI for segments of real estate market Regulatory reform for consistent risk pricing across banks and nonbanks

3) Existing fiscal space should be used for infrastructure within a sustainable MT framework Does Thailand have Fiscal Space? On the positive side: The overall fiscal balance of the public sector has been close to zero in recent years suggesting a good track record of fiscal discipline. The current cost of debt financing is low but likely to increase in the medium term. Now is the time for debt financing at fixed rates for new debt issuance. On the negative side: Quasifiscal activities by some SOEs are not properly tracked or reported. Risks of contingent liabilities are hard to quantify with the available information. Age-related spending is projected to increase steadily for demographic reasons, threatening fiscal sustainability beyond the medium term. Public debt and gross financing needs paths are below standard vulnerability benchmarks and below the Cabinet debt ceiling of 60 percent of GDP. Bottom line: Thailand has some fiscal space that should be used wisely. 3) Existing fiscal space should be used for infrastructure within a sustainable MT framework Does Thailand have Fiscal Space? On the positive side: The overall fiscal balance of the public sector has been close to zero in recent years suggesting a good track record of fiscal discipline. The current cost of debt financing is low but likely to increase in the medium term. Now is the time for debt financing at fixed rates for new debt issuance. On the negative side: Quasifiscal activities by some SOEs are not properly tracked or reported. Risks of contingent liabilities are hard to quantify with the available information. Age-related spending is projected to increase steadily for demographic reasons, threatening fiscal sustainability beyond the medium term. Public debt and gross financing needs paths are below standard vulnerability benchmarks and below the Cabinet debt ceiling of 60 percent of GDP. Bottom line: Thailand has some fiscal space that should be used wisely.

Public health and pension spending is set to rise due to rapid aging The increase in spending is driven primarily by demographics (changes in the old-dependency ratio) Aging will also lower labor force participation and potential growth 25 20 15 10 5 Public Health and Pension Spending (In percent of GDP) 2015 20 2050 0 JPN CHNKORTHA IND IDN LKAMYSPHLVTN Left unchecked, age-related spending is a threat to long-term fiscal sustainability 180 China 180 Korea 180 Thailand Public Debt (In percent of GDP) 1 80 1 80 1 80-20 -20-20 2000 2020 2040 2000 2020 2040 2000 2020 2040 2022 Status Quo Aging Less optimistic r - g

A less favorable interest rate-growth differential adds further risk 180 China 180 Korea 180 Thailand Public Debt (In percent of GDP) 1 80 1 80 1 80-20 -20-20 2000 2020 2040 2000 2020 2040 2000 2020 2040 2022 Status Quo Aging Less optimistic r - g 3) Existing fiscal space should be used for infrastructure within a sustainable MT framework Does Thailand have Fiscal Space? On the positive side: The overall fiscal balance of the public sector has been close to zero in recent years suggesting a good track record of fiscal discipline. On the negative side: Quasifiscal activities by some SOEs are not properly tracked or reported. Risks of contingent liabilities are hard to quantify with the available information. The current cost of debt financing is low but likely to increase in the Age-related spending is projected to increase steadily for medium term. Now is the time for debt financing at fixed rates for demographic reasons, threatening fiscal sustainability beyond new debt issuance. the medium term. Public debt and gross financing needs paths are below standard vulnerability benchmarks and below the Cabinet debt ceiling of 60 percent of GDP. Bottom line: Thailand has some fiscal space that should be used wisely.

A simulation with fiscal and monetary policy Asia Module of the Flexible System of Global Models 16 countries for Asia; 8 blocks for the RoW Households (liquidity-constrained, saving); firms Fiscal policy plays a key role in the economy Infrastructure investment and consumption Transfers (general and targeted) Taxes (VAT, PIT, CIT) Monetary policy generally follows inflation targeting Thailand: Infrastructure push under different financing and monetary policy In the baseline, monetary policy reacts to the infrastructure push, crowding out private demand With monetary accommodation, a flat interest rate encourages investment/discourages saving. With debt and monetary accommodation, GDP (and consumption) increase further. 4.0 3.0 2.0 1.0 Thailand: Real GDP (Percentage Points Difference) Public debt: + 1 % GDP 0.0 0 1 2 3 4 5 Lower transfers without monetary accommodation Lower transfers with monetary accommodation Debt with monetary accommodation

Thailand: Infrastructure push under different financing and monetary policy In the baseline, monetary policy reacts to the infrastructure push, crowding out private demand With monetary accommodation, a flat interest rate encourages investment/discourages saving With debt and monetary accommodation, GDP (and consumption) increase further. 4.0 3.0 2.0 1.0 Thailand: Real GDP (Percentage Points Difference) Public debt: + 1 % GDP 0.0 0 1 2 3 4 5 Lower transfers without monetary accommodation Lower transfers with monetary accommodation Debt with monetary accommodation Thailand: Infrastructure push under different financing and monetary policy In the baseline, monetary policy reacts to the infrastructure push, crowding out private demand With monetary accommodation, a flat interest rate encourages investment/discourages saving 4.0 3.0 2.0 Thailand: Real GDP (Percentage Points Difference) Public debt: + 1 % GDP With monetary accommodation and debt financing, GDP and consumption increase further 1.0 0.0 0 1 2 3 4 5 Lower transfers without monetary accommodation Lower transfers with monetary accommodation Debt with monetary accommodation

To reap higher growth dividends, critical elements must be in place Simulation results hold if risk premium is contained More broadly, critical pillars are: Quality projects that address country-specific gaps Credible fiscal anchors that look long term Inclusive and sustainable Social Security Reform Structural reforms in healthcare Automatic adjustment mechanisms in pension Better coverage and benefits revenue mobilization Pension reform to address design issues and population aging Pension Reform Challenges Harmonization Sustainability Coverage Adequacy Fairness Poverty Alleviation The pension system is fragmented in regimes for public, (formal) private, and informal employees. The retirement age, 55, and the contribution rate, 6 percent, are low. Over 60 percent of the working-age population is not covered by a formal pension. The average replacement rate for private sector workers (19 percent) is too low. Pensions for civil servants are much more generous, with higher replacement ratios, than for private sector workers. The old-age allowance (minimum pension for those without a formal pension) is low and untargeted.

How should revenue be mobilized? Increase the low VAT rate VAT Rates in 2015 (In percent) Average in Europe 20.6 Compensate low-income households Thailand: Consumption Loss per Decile After a 1 Percent Increase in VAT Rate (In percent of total consumption per decile) 0 Average in America Philippines 12 14.3-0.5 Indonesia Laos Cambodia 10 10 10-1 -1.5 Singapore Thailand 7.0 7-2 Malaysia 6 0 5 10 15 20 25-2.5 1 2 3 4 5 6 7 8 9 10 Source: IBFD. Source: IMF staff calculations. 4) Concerted reforms to foster inclusive, sustained growth Mitigate demographic drag Support capital accumulation Increase TFP Close gender gap in LFP Increase retirement age Facilitate skilled migration Reform education Upgrade infrastructure Relax limits to foreign equity stakes Facilitate PPPs Adopt best practices in doing business Eliminate untargeted subsidies (agriculture) Revamp competition law Restructure SOEs Reduce tax distortions (incentives for target sectors) Robust mechanism to identify and compensate vulnerable households

Reduce the excessive current account through a growth-driven process Substantially stronger external position Thailand: EBA Estimates and Staff Adjustments Actual current account (CA) 11.4 EBA CA estimates Cyclical adjustment 0.3 Cyclically adjusted CA 11.1 CA norm 1.1 CA gap 10.0 Policy gap 2.3 Unexplained residual 7.6 Staff-adjusted estimates Cyclical and transitory adjustments [3.0, 7.0] Terms of trade [1.0, 1.5] Tourism [1.0, 1.5] Political uncertainty [1.0, 4.0] CA gap [3.0, 7.0] REER gap (elasticity 0.6) [-11, -6] Two-sided intervention; but reserves Current Account, Capital and Financial Account, and Reserves (In billions of U.S. dollars) 50 40 20 10 0-10 -20 - Change in reserves Current account 2008 2009 2010 2011 2012 Capital and financial account 2013 Sources: CEIC Data Company Ltd.; and IMF staff calculations. 2014 2015 2016 EBA: Staff s adjustments of cyclical/transitory factors helped interpret part of the unexplained residual Thailand: Tourist Arrivals (In millions of persons) 34 Impact of Political Uncertainty on Private Investment 1/ (Regression coefficient) 0 32 28 26 Actual Trend 1/ -2-4 24 22 20 2012 2013 2014 2015 Sources: Authorities; and IMF staff calculations. 1/ Trend calculated using an HP filter since the mid-1990s. 2016-6 2015Q1 2015Q2 2015Q3 2015Q4 Source: IMF staff estimates. 1/ Rolling regression of private investment (percent of GDP) on the inverse of ICRG index (measuring political uncertainty), controlling for external demand. 2016Q1 2016Q2 2016Q3 2016Q4

Demographic factors are expected to increase the CA norm in coming years Aging Speed 1/ (Projected change in old-age dependency ratio ) Old-Age Dependency Ratio 1/ (Index; 1985=100) 0.35 495 0. 0.25 0.20 0.15 0.10 Thailand World 445 395 345 295 245 195 Thailand World 0.05 145 0.00 95 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 1985 1990 1995 2000 2005 2010 2015 2020 2025 20 2035 2040 2045 2050 Source: IMF staff calculations. 1/ Projected change in old age dependency ratio in 20 years, relative to current level. World refers to other EBA countries. Source: IMF staff calculations. 1/ Population aged over 65 divided by population between and 64 years old. Final remarks Thailand s economy is on a recovery path. Exports and tourism are engines of growth, but domestic demand (investment) and inflation are too weak Monetary policy should focus on returning inflation to target, while macroprudential policies address systemic risks Fiscal policy expected to do a lot. Infrastructure stimulus must be balanced against the fiscal cost of the rapid demographic transition Structural reforms are the only true long-term solution Domestic and external rebalancing through inclusive growth