No doubt the drama of policy uncertainty will continue. But what will be the end-game? Broadly speaking, we envision two scenarios: an extreme scenario and a baseline scenario. In the extreme scenario, prolonged political gridlock over policy leads to a liquidity seizure. Failure to ratify the fiscal compact results in handicapped liquidity support efforts on the part of the authorities and heightened market concerns. Rising risk premium leads to explosive debt dynamics, loss of market access and rollover difficulty, which in turn leads to even greater liquidity needs. With the cost of rescue mounting, internal country politics may further delay policy leading to a vicious cycle between rising rescue costs and policy inaction. There are signs that these risks are very real. For example, last month in late July, Spanish bond yields recently jumped up again over 7 percent, making the country’s debt dynamics unstable. There has also been upward pressure on Italian bonds. The ECB came to the rescue by promising to “do whatever it takes to preserve the euro as a stable currency”. Markets stabilized and yields came down. The US stock market also picked up. Nevertheless, the risk that yields could erupt again persists, especially if concrete progress in implementing policy does not take place. In the event of a liquidity seizure, there will be considerable spillover into global financial markets. Trade will decline amid the credit crunch that will surely follow. Asia, Thailand included, will not be spared the turmoil. So that’s the extreme scenario.
Our research shows that the gains from structural change can be considerable although adjustment costs, in terms of the reallocation of labor and capital, will also be significant. Now we arrive at the third and final question. Given the euro crisis and Thailand’s prospects for growth, what should monetary policy do? The dilemma here is how to bridge short-term stabilization with long-term goals of structural change. The challenge for policy is to maintain an overall framework where the trend of increasing economic integration can continue while containing crises. Given our baseline scenario of a prolonged recovery without a liquidity seizure we lean towards long-term goals – for example, maintaining capital flow liberalization, financial sector liberalization and market-led exchange rates – but with a readiness for monetary stimulus should a clear need arise. Let me discuss the policy tools at our disposal and how they fit into our overall policy objectives. On the interest rate, the policy rate has been on hold at 3.00 percent since January this year. At the moment we view it as supportive of growth amid global risks and consistent with our inflation target. However, I must stress that the interest rate is poised to go either way depending on developments in the advanced economies, in particular the euro area and the impact on the overall Thai economy. We recently saw how the impact of the euro crisis is spreading to Asia in the form of a broad-based slow-down in Thai exports.