Thailand's economy isn't a Land of Smiles

Farmer Pramote Kongburi inspects his dried rice field in Praek Siracha, Chainat province, Thailand, on July 3, 2015.
Dario Pignatelli | Bloomberg | Getty Images

Thailand's worst drought in a decade appears to have ended, but the damage could cast a shadow on the economy for months to come.

"Thailand has turned from the land of smiles to the land of frowns. Indeed, deep frowns that are unlikely to cheer anytime soon," ANZ economists said in a recent note.

The crippling dry weather that first emerged in late 2014 is no longer present in the country's 67 provinces, the deputy head of Thailand's disaster prevention department told Reuters last week. But with more than 40 percent of the country's population engaged in agriculture, the drought has exacerbated troubles in an economy already weighed down by slowing manufacturing, shrinking exports and rising external debt.

That's spurred sharp growth downgrades. Credit Suisse is now expecting 2015 economic growth at 2.5 percent on year, down from 3.1 percent previously, while JP Morgan is pricing in a 2.6 percent rise, down from a June estimate of 3.5 percent.

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Assessing the damage

Thailand is one of the world's biggest rice exporters, but the drought has impacted 80 percent of rice farming land, possibly causing a 15-20 percent drop in output, according to the Thai Rice Exporters Association.

"Not only is offseason [rice] crop production down, even planting of the main [rice] crop season will likely be delayed to August from June-July normally," said Credit Suisse research analyst Santitarn Sathirathai.

To be sure, agriculture as a whole accounts for less than 10 percent of Thailand's gross domestic product (GDP), but "the more significant drought-related risk to growth will be if water rationing also affects industrial areas, potentially curbing manufacturing output," warned Benjamin Shatil, a JPMorgan economist, in a report earlier this month.

Reduced output in turn, will hurt employment.

"We believe the drought effect on lower farm output, led by a 30 percent drop in paddy output in January-May, worsened labor market conditions as farm employment shed 700,000 jobs in June," noted Citi economist Jun Trinidad.

The unfavorable weather also depresses agricultural incomes, which has a knock-on impact on consumer spending.

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"Rural households are hit by a perfect storm in agriculture, drying up their cash flows when the debt burden remains elevated," said Credit Suisse's Santitarn, referring to the nine consecutive months of declines in international rice prices and the ruling military-backed government's efforts to halt subsidies.

"Although the government has stepped up to provide $1.8 billion worth of soft loans to support farmers, we suspect the damage has been done. We expect this to act as further headwinds to consumption going forward," Santitarn said.

Consumers certainly don't seem to be in the mood to open their wallets much.

Consumer confidence witnessed its sixth straight month of declines in July, according to the ANZ-Roy Morgan index, and further depreciation is likely.

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"Looking ahead, we expect consumer sentiment to remain persistently downbeat, with the economy failing to gain traction and agricultural income depressed by the protracted drought," ANZ warned.

Interestingly, reduced crop harvests won't necessarily see domestic food prices spike.

"The pass-through to consumer price inflation has been very modest so far," stated JPMorgan's Shatil. "That may reflect the fact that the government still has large stockpiles of rice, but is likely also a consequence of the benign global food price environment, which continues to pull down headline prices."

Stimulus isn’t the only answer

Faced with a sluggish economy, the Bank of Thailand will likely cut interest rates to a historic low of 1.25 percent later this year from 1.5 percent currently, Credit Suisse said.

But monetary easing alone may be insufficient to deal with the drought consequences, according to ANZ. In addition to easing, it believes the Bank of Thailand will also allow the baht to weaken.

Citi's Trinidad agreed: "A bias for a weak baht will persist, which can improve farm export earnings despite lackluster volumes and thus support rural consumption."