Countries in Asia Prepare for European Debt Crisis Fallout

Sources:

Agence France-Presse: Asian Countries Cut Rates amid Global Economic Woe

FT: Indonesia Slashes Interest Rates by 50 Basis Points

WSJ: Asia—Pacific Economies Gird for Turbulence

WSJ: Some Asian Economies Reflect Strains

Countries throughout Asia and the South Pacific have responded to the European debt crisis and waning global demand by lowering their benchmark interest rates. Australia, China, Indonesia, Pakistan, and Thailand have all decreased benchmark interest rates in recent months, and Malaysia, New Zealand, Singapore, and South Korea are considering other policies to inject more money into their economies.

The use of monetary policy to spur spending and economic growth represents a shift in policy for many of these countries. In recent years, these countries have experienced robust economic growth and have been primarily concerned with curbing high inflation. This concern has led them to maintain high interest rates to decrease the money supply—and thereby inflation—by making saving more attractive and borrowing more expensive. However, the once-rising inflation rate is now falling in many of these countries and economic growth has also decreased. It is this reversal in growth that has convinced many of the countries to change course.

The benchmark interest rate is the rate of return on new government-issued bonds. In theory, lowering the benchmark interest rate can decrease the value of a country’s currency and spur its export industries, which is an effective way to generate economic growth. For example, if Indonesia lowers its benchmark interest rate, demand for Indonesian bonds will fall because they are not as profitable as before. Since investors use the Indonesian currency (rupiah) to buy government bonds, when demand for the bonds falls so does demand for the currency, which lowers its value in accordance with supply and demand principles. If the rupiah costs less on the foreign exchange market, it will be cheaper for businesses in the United States, for example, to buy the rupiah required to pay Indonesian manufacturers for their goods. The lower currency value will, therefore, jumpstart Indonesian export industries and generate economic growth.

A lower benchmark interest rate also has an effect domestically. When interest rates are lower, saving is less attractive and borrowing is cheaper, which encourages people to spend their money rather than save it. The additional spending increases overall demand and economic growth.

Some analysts question whether policies aimed at increasing economic growth at the risk of increased inflation are necessary. Although economic growth rates have fallen of late, a recent Asian Development Bank report indicated that Asian countries are still on pace for 7.5% growth in 2011. These analysts believe that this level of growth is appropriate given the global economic downturn, and think that preventing the potentially destabilizing effects of inflation on food and commodity prices should be the countries’ priority.

Whether this policy shift represents a temporary response to worsening conditions in Europe or a more prolonged transformation of Asian monetary policy remains to be seen. There is no doubt, however, that Asia’s path forward will be closely observed and scrutinized by the global community.

Historic Flood Threatens Thailand’s Growth

Sources:
CNN: Threat of Disease from Historic Flooding Looms in Thailand
FT: Thailand Slashes Growth Forecast After Floods
Herald Sun: Thai Authorities Warn of Electrocution
WSJ: Submerged Thailand Losing Out to Peers

On October 28th, the Bank of Thailand lowered its prediction for the country’s economic growth rate in 2011 from 4.1% to 2.6% due to ongoing flooding throughout the country. Uncharacteristically heavy rain since mid-July has caused Thailand’s worst flooding in fifty years resulting in $6 billion of damage, 427 deaths, and 2.2 million people displaced.

Although the capital city of Bangkok—accounting for 41% of the country’s $319 billion economy—has not flooded, the northern and western portions of the country are submerged in waist-high water contaminated with sewage, garbage, and dead animals. Health officials in Thailand warn that these areas will be susceptible to malaria, diarrhea, and other serious, but usually non-life threatening, diseases. Drowning and electrocution have caused most of the deaths so far, but these health risks threaten to kill many more.

The international community and the Thai government are attempting to ease the effects of the flooding by providing health safety information, mosquito nets, and money among other things. For its part, the Thai government has committed 50,000 military officers to help evacuate between 100,000 and 200,000 people to shelters across the country. The government has also pledged $25.97 billion to provide aid for those affected by the floods and to prevent future flooding.

Some submerged communities, however, believe the Thai government has not done enough to prevent damage. Villagers in one district dug ditches around a gate designed to keep floodwater in their community and out of central Bangkok. The government quickly refilled the ditches to prevent floodwater from pouring into Bangkok and assigned 100 police officers to watch over the gate 24 hours a day. The Thai government wants to keep central Bangkok dry because it is the engine of the Thai economy, but residents outside of Bangkok are understandably frustrated with the government’s priorities.

Not only have communities been devastated from the current flooding, but now some foreign investors are convinced that Thailand may no longer be a stable place to setup business. The flooding, coupled with recent political events, has distracted the Thai government from advancing necessary infrastructure projects that often attract foreign investment by lowering production costs. Foreign investors are important to the Thai economy because they create higher paying jobs and spend money in the local economy, both which increase employment and generate economic growth.

Although the economy is expected to recover to some degree due to government reconstruction and the rebuilding of major automobile plants which have been damaged by flooding, one economist believes that Thailand is at a tipping point in terms of its ability to attract foreign investors. Whether foreign investors will continue to locate in Thailand depends on whether Thailand can rebuild its infrastructure and ensure investors that it has taken important steps to prevent future flooding. The government will also face pressure from its citizens to provide immediate aid to flooded communities. Since Thailand has limited resources, the government must determine how much funding to allocate to short-term relief and long-term rebuilding. However, striking the correct balance will be difficult.