Widespread Floods Are Credit Negative, but Thai Government Finances Remain in Good Order

Thailand’s worst floods in half a century have exacted a significant toll in terms of lives and economic costs. Floodwaters have claimed the lives of more than 300 of the Southeast Asian nation’s citizens, while causing extensive destruction to property and disruption to economic activity. Although credit negative for Thailand (Baa1 stable), we do not expect the deluge to undermine the government’s creditworthiness.

 

Water now covers 4 million acres (1.6 million hectares)—a third of Thailand’s provinces—in the north, northeast and centre of the country, disrupting industry and displacing families. The floods have significantly affected agricultural and manufacturing production, as well as distribution networks and commercial activity in affected areas. Supply chains have been disrupted, notably among automobile manufacturers, while around a quarter of the current crop of rice has been destroyed. Thailand is the world’s largest rice exporter.

 

The central bank previously estimated the damage to industry and property at more than THB120 billion ($3.9 billion) or roughly 1.2% of GDP. However, the potential for flooding to spread to Bangkok poses upside risk to these projections and we assume the economic costs of this natural disaster will exceed THB200 billion (2% of GDP). Combined with the deterioration in the outlook for external demand, real GDP growth in the second half will slow significantly. The Bank of Thailand has indicated 2011 economic growth may be lower than 3% as compared to the 4.1% pace it previously forecast, while Finance Minister Thirachai Phuvanatnaranubala has indicated growth might barely reach 2% owing to the magnitude of disruption. We expect real fourth-quarter GDP to contract in annual and quarterly terms, and estimate full-year GDP growth at 2.8%.

 

Last week, the Bank of Thailand chose to hold interest rates steady, effectively completing its tightening cycle in order to support an economy facing a double-whammy from the floods and softening external demand. This crisis does not represent a structural break in terms of the country’s productive capacity, and economic growth should climb back toward its trend rate of over 4% in 2013.

 

The floods will affect government finances, increasing expenditure and depressing revenue. On 18 October, the Cabinet approved an additional THB50 billion to the proposed 2012 budget for post-flood reconstruction, bringing the projected deficit to 4% of GDP. Government agencies have also been instructed to set aside 10% of their allocations for investment and operating expenditures to free up funds for recovery efforts, amounting to a total of around THB80 billion. A further THB70 billion has been reallocated from other parts of the budget. The government is also likely to put together a sizeable aid package in a mid-year supplementary budget.

 

In addition to disaster relief, we anticipate a ramp-up in government spending on flood management and mitigation over the duration of the current administration’s remaining four years in office. However, fiscal rules will mitigate the risk of a significant or permanent deviation from the cautious approach that has led the central government’s fiscal deficits to average around 1.5% of GDP over the past 10 years.

 

Nor do we expect the floods to undermine the government’s creditworthiness. The robust economic recovery over the past three years and post-crisis stabilization of government finances support Thailand’s creditworthiness. A steady repayment of external debt and accumulation of official foreign exchange reserves have reduced government balance sheet vulnerability to shocks. The government will have ample fiscal space to absorb flood-related costs without prompting a permanent deterioration in its debt ratios.