To meet these challenges from without, it is critical that the Thai economy build strength from within: by continuously improving the flexibility and efficiency of its firms, the resiliency of its households, and the competitiveness of its business environment. But beyond getting the fundamentals right and strengthening them, the Thai economy needs a strategic policy package that builds a system that allows for constant self-correction – one that also let the economy regain its strength quickly after a severe negative shock. That system should be underpinned by a strong link to the world economy, which will encourage innovation and efficiency. Specifically, I should underscore that this approach requires policy markers to focus on achieving three key objectives, namely managing volatilities especially those emanating from volatile global capital movements; building resiliency in both real and financial sectors; and fostering long-term productivity improvement. Looking ahead, the pressing and practical challenges we face in the near term are three-fold and indeed they are also inter-related. They are “hot money” inflows and large inflows in general, pressure for rapid domestic currency appreciation, and finally, the potential loss of monetary autonomy in the sense of independent interest rate policy. Being part of the fast growing Asia, Thailand and its neighbors have become attractive destinations for international investors – although the more powerful underlying reason may ironically be a medium-term flight from US dollar assets since 2002. With large capital inflow comes pressure for these currencies to appreciate. In this experience, some currencies appreciate faster than others.
While capital inflows are generally beneficial, they are by no means cost-free. Potentially, large inflows of capital can lead to exchange rate overshooting, hurting some segments of the real sector that may have trouble adjusting. Moreover, they could seep into speculative activities and drive up asset prices. Especially vulnerable are the real estate and equity markets. As these markets heat up, more capital inflows often find their ways in, creating potential bubbles. Invariably as the bubbles burst, balance sheets of firms, individuals, banks as well as the government will be affected. The burst of these bubbles, when coupled with capital outflows, could have devastating effects. The Asian crisis over a decade ago is a good reminder for us. Currently, the Bank of Thailand has a set of tools at its disposal to help the economy deal effectively with capital inflows. These tools include (1) the flexible exchange rate and foreign exchange market intervention, (2) macro-prudential measures, and (3) capital account regulations. Together, these tools are indeed powerful, and a careful coordination is required when using them. Let me briefly elaborate on the use of each. In our framework, a flexible exchange rate is a core tool, since it can act as an automatic stabilizer towards capital inflows in general. As capital pours in, especially if driven by favorable growth potential of the economy, a flexible exchange rate can act as an automatic stabilizer that would help lessen the chance of overheating and dampen pressures on other asset prices which otherwise might turn into a bubble.