Investor Spotlight: A frontier market too far?

A foreign investor looking in, Jeremy O'Friel ponders Thailand's fortunes

"The currency crisis of 12 years ago does not feel long enough ago to be forgotten."

Of all the lessons learned from the credit crisis of 2008 and beyond, perhaps the starkest was that liquidity remains king. As Benjamin Franklin once noted – the only thing more important than return on capital is return of capital. It is within this mindset that one tends to examine the potentially lucrative markets of Southeast Asia from a hedge fund manager’s point of view, namely with one beady eye on liquidity, or rather lack of it.

Clearly, there are tempting reasons to be involved in Asia. The region seems, through a combination of solid oversight and historically high savings rates, to have avoided the banking crisis suffered in the supposedly more sophisticated parts of the financial world, leading bourses in such cities as Kuala Lumpur and Bangkok to within spitting distance of new highs. But fears linger and many in the investing community remain psychologically scarred by the ‘Asian flu’ of the 90s. Given the complexity of the instruments employed therein, the masters of the hedge fund universe remain even more reticent, and are unlikely to plunder countries such as Indonesia, Thailand or Vietnam until they see clear and sustained evidence of higher levels of liquidity and freedom from state intervention in currency and other markets. Looking specifically at the Thai situation, one must examine all three of the currency, fixed income and equity markets to ascertain what the prospects are for a further development of the market and what needs to happen in order to entice more foreign investors.

Clearly, Thai equities are on the rise, with inflows next year poised to hit THB100m and the SET having recorded again of a shade under 26% through time of writing, making it one of the best performers worldwide. Yet the concerns centre around three important features – concentration, size and political backdrop. With banks making up 5 of the top 10 issues by market capitalisation (Thanachart, Bangkok, TMB, Siam Commercial and Kasikorn), hedge fund managers perhaps feel that they would be better off looking elsewhere for diversification, whilst it is only thirty five years ago that the liquidity fell to sufficiently low levels that the Bangkok Stock Exchange - the predecessor to the Stock Exchange of Thailand – ceased operations. It was no surprise that Thailand failed to make the grade in being included in Goldman Sachs’ Next-Eleven (N11) list of countries to follow the BRIC nations into the big-time, even though Asian neighbours Vietnam, Indonesia, South Korea and the Philippines did. Finally, the riots of earlier in the year are still the first thing that observers from outside of the country think of when Thailand comes under discussion. One is bound to recall the civil unrest disruption was deemed sufficiently serious for the SET to temporarily close.

The currency markets are similarly viewed with distrust. Again, the currency crisis of 12 years ago does not feel long enough ago to be forgotten. The Thai (and indeed Malaysian) central bank have two clear goals – stability of exchange rates and low inflation – and are not averse to direct intervention and even the implementation of currency controls to achieve the former. As has been learned by many other countries such as the United Kingdom, providing artificial support or resistance for any particular currency can be an expensive and ultimately fruitless exercise. Yet in the absence of such intervention, the presumed march upwards of the Baht could damage Thailand’s export-led economy. The absence of such upside potential in the currency is another reason for hedge fund managers to look elsewhere for a bit of free carry whilst holding equity positions.

Bond markets are perhaps the most attractive place of the three to dabble. Ironically, the success of domestic fixed income securities sector owes much to the same crisis that scarred so many others. In the aftermath of 1997, the Thai banks were reluctant to lend to local industry and so companies turned to the bond market. The inevitable forces of competition over the next 10 years led to lower borrowing costs, longer-dated maturities and fixed rates to such an extent that local banks now find it difficult to compete. Unfortunately though, bonds will always play second fiddle to equities in terms of where hedge fund managers place their assets and so again, international speculative appeal is probably limited.

In summary then, it is fair to conclude that unfortunately Thailand is a country that is still viewed with a certain amount of scepticism. Until the international investor sees a lower concentration and higher volume in equities, coupled with more freedom of exchange rate, Thailand is likely to remain peripheral in the opportunity set of even the most daring emerging markets hedge fund manager.

Jeremy O’Friel is the Managing Director of Belmont Investments, founded in 2009 with offices in Dublin and New York. Registered with the CFTC and NFA as a CTA and CPO, it has entered into an exclusive agreement with Altegris Portfolio Management (APM) to distribute all funds originated by the firm to investors outside of the US. Jeremy regularly visits clients in Thailand including MBMG Group and can be contacted through the MBMG Group on info AT mbmg-international.com

APM, a Registered Investment Advisor with client assets of roughly $2.75bn, is based in California. Formerly part of the Man Group, independent since 2002, APM specialises in managed futures and hedge fund strategies, with links to managers such as William Eckhardt and John Paulson. 

MBMG Group is a personal and corporate advisory and research practice with offices in Bangkok and throughout Thailand. MBMG Group was a pioneer of hedge fund research and recommendation within Thailand, and advises clients on assets of over $165 million, invested in a diversified range of assets managed by leading global experts.

This article was first published in Business Report Thailand, Issue 1, October 2010.

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Why Thailand needs market reform: Khun Smith Jingkaojai

An insider gives the Thai economy a health check and sees the need for treatment

Smith Jingkaojai is a senior member of the international business community who has the ear of the Thai government. In a career stretching over 15 years he has worked across the globe for Morgan Stanley, Bankers Trust and Credit Suisse First Boston. Currently head of Corporate Finance at Asia Plus Securities, he serves as an honorary advisor to the Thai parliament’s financing and banking committee, the only member from the financial services sector. He is also an advisor to the Board of Trade, the Thai Chamber of Commerce and the Federation of Thai Industries.

Khun Smith is a free market capitalist in a country that he feels has yet to fully embrace the rigours and benefits of a free market economy. Meeting with Business Report Thailand at the Sukhothai Hotel in the heart of Bangkok’s financial district he is keen to share his analysis of the Thai economy. In a wide-ranging conversation he touches on topics as diverse as the legislative framework under which businesses operate here and how it can drive away foreign capital. He also looks at the surge of the baht against the dollar and what that means for exporters and questions why there is THB1.7 trillion languishing in Thai bank vaults. 

All views expressed herein are his own and do not necessarily represent those held by affiliated companies or institutions. 

Business Report Thailand (BRT)

Despite widespread and almost unprecedented political unrest this spring, Thailand’s economy continues to prosper. Some call it the Teflon economy – how do you account for it?

Khun Smith

It shows the resilience and strength of the Thai private sector. Capitalism is often at its best when sailing amid stormy waters.

 We inhabit a country of 65 million people many of whom are very well educated and who fully understand that we are part of the international, global community. In many ways the people are ahead of the politicians - many see the need to engage with the markets and for reform. The weaknesses of our legal framework are constantly being exposed.  Two areas are of particular concern to me – the legal framework under which business is conducted and the enforcement of the rule of law. Where things are not up to par, changes must be made.

We have to maximise our potential. We live in turbulent times yet our economy grows so we are forced to ask ‘what could our full potential be?’ At this time our glass is partially full, yet the potential of the empty half is huge. This has been recognized by foreigners and now ever more so by many Thai people. This potential can only be realized if, and only if, we live by the rule of law, democracy and the drive of capitalism.

BRT

And what about the political strife?

Khun Smith

That’s been a real wake up call and clearly the issues involved are not easy to solve. Don’t forget foreign business is always very well informed and in tune with what’s taking place. The worry for them is the situation has not been resolved and there is little light at the end of the tunnel. The government has done as much as it perceives it can to deliver and clarify concerns. Whether or not that is enough remains to be seen. In many ways the main problem is beyond government. In financial terms it is the systemic risk we are facing, but business will tackle the issues and take strategic decisions. Capitalism, the ultimate example of ‘the survival of the fittest’, will prevail. The only sadness is the lost opportunities and the feeling that we are doing well, but that we could be doing so much better.

BRT

How can Thailand best compete with its neighbours and against giants like China?

Khun Smith

We need to get back in the game – the international game. This involves trade obviously, but also, and most importantly for me, the capital markets and the financial service sector. By that I’m really talking Wall Street – the equity and fixed income markets. We need to get back into that international circle. If you’re not a member of that club you can’t compete. A case in point - when was the last time you saw the SET mentioned on CNBC? It never is.

The cost of capital is reflected right the way down to the cost of goods and services. We need legal reform that opens up Thailand to the global business community. Business hates uncertainty and tries to price the cost of risk. The existing legal environment poses and reveals uncertainty, which I believe deters new business, particularly from overseas. 

BRT

The Stock Exchange of Thailand (SET) has been criticised for not helping capital markets achieve their full potential. Do you share that view?

Khun Smith

The SET is an essential part of the capital market, but accessing this market needs to be made quicker and easier, without compromising the integrity of the system. The new administration is well aware of this and has a very hands-on attitude. 

You have two main markets in the financial world – the bank and capital markets. As Thailand’s economy started to grow the bank market was invaluable at accessing capital from savers and, bridging the gap between saver and investor - becoming in effect an intermediary. The banks have performed well, are generally of a recognised international standard and hopefully, as time goes on, their transaction costs should fall.

The capital markets both equity and fixed income are a different story. The fixed income market consists of the debt market, the foreign exchange and commodity markets and is way larger than the equity market – perhaps by 20 or 30 times. In Thailand we have an active and successful equity market, but the fixed income market is yet to mature.

In theory, both markets - the equity and the fixed income markets - run parallel, in tandem. In a mature and efficient capital market like Wall Street, when one is up, the other is down. If the equity market is up, capital will move from fixed income to stocks and the fixed market will decline. And of course when equities are down money will race back to the fixed income market. 

The problem for Thailand is that our markets are not balanced. 

When equities are down the money has no place to go other than back to the banks. The result is we now have THB 1.7 trillion sitting in cash doing very little. Like everybody else money needs to work for a living and not take an extended holiday in a bank vault!

BRT

The baht has continued to climb steadily against the dollar much to the alarm of exporters. Is the currency overvalued?

Khun Smith

It’s not for me to say what the appropriate level of the baht should be. What I will say is that the true cost of goods and services in any country will ultimately be reflected in its currency. It’s like being at school. If a student is working hard and passing exams with good grades then that will be reflected in their scorecard. The currency is Thailand’s scorecard.

But that’s not the whole story. The relevant authority here is the Bank of Thailand (BOT) and they have taken what they believe to be the correct course of action in respect of the currency. But is the authority in step with the markets and the private sector? This then raises the issue of accountability. Ultimately the result of all this is felt by you and me, the private citizen and consumer – we suffer or prosper and who is responsible for that? Never underestimate the importance of accountability in the capitalist system.

BRT

Inflation is above 3%. Are you happy with that figure?

Khun Smith

Well the short answer is no. The saving rate is currently 1% and if as you say inflation is at 3% then we are all poorer by 2% year on year. One of the problems, as I mentioned earlier, is that we are out of touch with the international markets and often don’t price things fairly here. The result being that some goods and services don’t reflect their real worth when set in the context of the wider world.

BRT

Looking ahead to 2015 and the start of the ASEAN Economic Community, do you expect there to be free trade and free movement of labour in the region, or will countries resort to protectionism?

Khun Smith

The movement of labour is already happening. The ASEAN EC will give it a legal stamp. Look at workers in the fishing sector here; some say that up to 98 per cent are not Thai. Whatever the true figure, that is the reality on the ground. It’s nothing new. As a country’s labour force moves up the salary ladder a vacuum is created and then filled by people from elsewhere. We just need to recognise this issue formally - whether we like it or not. Systemise the way the labour market works, tax it and then it can contribute to the economy. For me it’s capitalism at its best. Market forces will dictate and prices fall.

BRT

What are the prospects for the Thai economy in the coming year? Where do the greatest challenges lie?

Khun Smith

Capitalism, which is sometimes called the ‘least worst economic system,’ tends to thrive in a true democratic environment. The implementation and respect for the rule of law is the most critical issue for this country. 

When a country is at risk of defaulting on interest and principal payments it’s know as ‘Sovereign Risk’ in the fixed income markets. In some circles this term has already been applied to Thailand because of its political-economic circumstances and that is clearly a worrying development. As it happens, a government seminar will be held on this matter shortly.

In many ways this is a young country, with an energetic young population who are keen to take the country to the next level. Older generations need to understand that it’s time for them to move on and let market forces take their course. Democracy and capitalism working together can steer this country to a bright future. But if the country forsakes these ideals, a swift punishment will ensue and I would genuinely fear for my children’s future and that of my beloved country.

This interview was first published in Business Report Thailand, Issue 1, October 2010.

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ASEAN’s Lost Leader

A regional leader four years ago, Thailand’s ranking has slipped, but investors seem unperturbed

"As the Thai military engaged in sporadic armed clashes across Bangkok in May, business at Thailand’s large industrial estates on the eastern seaboard surged."  

Since the September 19, 2006 coup that ousted then-Prime Minister Thaksin Shinawatra, the perception of Thailand as a regional leader has deteriorated, helped in no small part by a string of domestic debacles including Suvarnabhumi, Pattaya, and Bangkok’s recent demonstrations.  Thailand, domestically-occupied, has appeared less internationally assertive since these crises began. 

At a time when the Obama administration has sought to rebuild US relations in South East Asia, PM Abhisit skipped a recent Nuclear Security Summit in Washington, DC as the conflict intensification in Bangkok.  Instead, Foreign Minister Kasit attended, staying long enough to make controversial off-the-record comments regarding the monarchy during a speech at Johns Hopkins SAIS.  Other initiatives launched by Bangkok stalled under the previous military administration.  A regional grouping of Thailand’s neighbors intended to boost development in Cambodia and Laos stagnated.  

Thailand’s loss can be seen as other South East Asian states’ gain.  Indonesia’s thriving democracy is attracting ever-increasing attention from the United States.  Just five years ago Thailand’s clout in ASEAN allowed it to persuade Burma to pass on its ASEAN Chairmanship, currently held by Vietnam. Today, its ranking in the regional hierarchy has slipped. 

The effect of domestic political instability and a foundering international perception of Thailand’s economy is not always clear.  As the Thai military engaged in sporadic armed clashes across Bangkok in May, business at Thailand’s large industrial estates on the eastern seaboard surged.  

Car sales increased 60 percent over the previous year as fires coursed through Bangkok’s banks and shopping centers.  External demand for Thai exports supported over six percent economic growth throughout the crisis and the first half of the year.  Despite tumbling numbers of foreign visitors to Thailand, growth held steady.  Investors bullish on the Thai economy have helped the Baht perform among the best of all Asian currencies.  

Not all indicators of Thailand’s political and economic health have been quite as upbeat.   

Thailand has fallen ten places in the World Economic Forum’s Global Competitiveness Index since the 2006 coup, mainly due to declining ratings of social unrest and political stability.  While the absolute fall may not seem extreme, Thailand, now 38th, has certainly lost relative standing compared to regional neighbors like Vietnam, which surged from 75th to 59th in the last year, following Indonesia’s leap from 54 to 44th.

Political crisis has undoubtedly hurt Thailand economically;  the 2008 airport closure shaved three percent off nominal GDP alone.  The country also suffers from suppressed levels of consumer and business confidence.  Yet the level of foreign direct investment (FDI) into the country has remained steady at between US$7-9bn annually since Thaksin’s military ouster.

Thailand’s political neuroses can seem to have little impact on economic indicators.  Examining the time horizon of investments and long-term sensitivity to risk may help to reconcile the yawning gap between Thailand’s politics and economy. 

Supply chains which incorporate Thailand’s industrial and automotive manufacturing sector were established during times of political stability and are difficult to alter in the short term.  Investors with a low appetite for risk halted construction of new facilities following the 2006 coup and 2010 protests, but a developed sector remained in place.   So far, firms have seemed willing to endure occasional crises and increasing political risk. Violence by protestors has also been directed at banks and commercial retail destinations far removed from export production centers.  Should the level of political risk continue to rise, or should damage occur to facilities which operate as part of supply chains, investors would certainly reassess their positions in Thailand and would likely alter physical capital investment to other locations.  The effect of that slow draw down on export growth, coupled with weak domestic demand and a lack of other competitive industries with growth potential, would result in anemic future growth.  

A government preoccupied with domestic instability runs the risk of distraction, but also has the potential to undermine future growth.  The 2007 constitution, written under military administration, outlined new benchmarks for businesses operating in the country.   

In December 2009 Thailand’s Supreme Administrative Court upheld a ruling suspending industrial projects at the Map Ta Phut industrial zone for failing to comply with environmental and health impact assessments – affecting both PTT Group and Siam Cement, the country’s largest energy and industrial conglomerates respectively.  It is such incidences, alongside the unfolding constitutional dispute over 3G licensing that has undermined the ‘security of expectations’ that Thailand can offer investors. 

The current administration’s continued preoccupation with Thaksin has lead to a deterioration of investments across borders as well.  In a move seen by many as a rejection of Thaksinite policies, Foreign Minister Kasit announced last year the termination of a Memorandum of Understanding between Thailand and Cambodia.  The agreement authorized joint oil and gas exploration and development in a section of the Gulf of Thailand disputed by both states.   Clearly, past domestic spats are having international consequences.

Thailand’s economy, ultimately, is operating on borrowed time.  Political stability and a booming economy in the early 1990s and the first half of this decade were central to long-term investment projects that continue to buoy Thailand’s economic growth.  This sector has also paradoxically been one of the least-affected by the recurrent and often-violent political strife which has continued to play out in Bangkok.  

The World Bank recently noted that the Thai economy runs on one engine: exports driven by external demand.  This engine thus has two characteristics.  It is detached from domestic political affairs, and it has a long-term investment horizon.   Because of this disconnect, Thailand’s beleaguered political system seems to have surprisingly little effect on macroeconomic indicators.  The question though, is how long Thailand can continue to operate with ever-increasing levels of political risk and continue to attract renewed investment based on manufacturing for export?  If firms decide that regional players with more stable political conditions—such as Vietnam—are safer investment destinations, then Thailand will be left with sagging domestic demand and a battered tourism industry. As regional economies become more robust, Thailand may also miss out on a rising tide of intra-ASEAN investment. It is always difficult to estimate just how long the short-term is, and how soon investors will decide to seek greener pastures or avoid initial investments entirely.  

For Thailand’s current administration, this pressing question takes precedence. BRT

This article first appeared in Business Report Thailand, Issue 1, special focus report on 'Thailand's ASEAN Economy', October 2010.

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ASEAN's Automotive Affair

Thailand, ASEAN, +3 and the future – The automotive industry sits this one out

"It has long baffled observers that Bangkok has no overt desire for unique models, brands or 100 per cent IP ownership a la Malaysia or China"

The auto industry invented globalisation and is bigger and more powerful than FTAs. It also doesn't conform to the norms of market drift. So the auto industry in Thailand remains relatively unaffected  by the knockabout of Thai politics and views ASEAN+3 with equanimity or even indifference.
Few vehicles exported from Thailand find their way to Japan, Korea or China anyway – or Thailand's other major export markets, Europe and the US, for that matter (although Thailand remains the world's second largest pickup market, its taste is for one-tonners, considerably smaller than those sold in the US). Some 95 percent of total exports go to Africa, Middle East and Oceania, in addition to other ASEAN nations, which also import into Thailand. Indonesia, Malaysia – and to a lesser extent Philippines and Vietnam – also have local production or assembly and have benefited tremendously from AFTA, although the implementation of the agreement has been generally and sometimes infamously inconsistent. Kuala Lumpur and Bangkok remain hardly on speaking terms over the former's protracted delay in allowing Thai-built vehicles into Malaysia at the agreed rates of duty in order to 'protect' its national carmaker Proton and its other local brand Perodua (owned by Daihatsu and thus a subsidiary of Toyota), although Protons are now on sale in Thailand. (Also starting to be seen on Thai roads are Chinese brands – Chery and Geely.)
The vogue is for individual FTAs, often prompted by automakers seeking outlets for production at viable rates of duty (eg the one between Thailand and Australia). Most ASEAN nations are developing individual agreements with outside countries as they try to reduce their dependence on trade with China, Japan and the EU.
Senior industry executives privately voice great fears about India (more than China because of the high probability of oversupply in India, while China has struggled to keep pace with demand) and its auto industry's eastward expansion following its FTA with Thailand. Tata has pulled out of the Thai eco-car project, which mandates the use of 1.4-litre or smaller engines that deliver at least 5L/100km economy and comply with Euro IV emission standards. But its bargain-basement pickups are finding favour with the large Indian diaspora there at the expense of more established brands, while the Nano was shown at the Thailand auto show in Bangkok last December and has been tested in local consumer clinics (with less than stunning results, according to insiders). The car debuted in India with a base price below USD2,500.
Observers believe Tata baulked at the eco-car programme requirements: an immediate USD215 million investment and annual production of at least 100,000 units within five years. Instead, Tata is moving forward with plans to launch its Xenon luxury pickup truck in Thailand. It plans to produce up to 20,000 of the vehicles per year at a new plant in Bangkok, and capture 5 percent of the market by 2014.
Japan-based OEMs account for four in five vehicle sales in ASEAN and there is little likelihood of change. Hence more than five years of wrangling over Thailand’s eco-car programme: the Japanese 'big two', for so long now cosy with the Bangkok ruling elite, got their way as the rules were framed to enable Nissan and Toyota to produce versions of existing Japanese or European minicars. European carmakers have no use for yet another plant to build their own minicars and no market to speak of locally.
However, Mitsubishi, which plans to make about 50,000 of the vehicles in the first year of production, is expected to be partnered by either VW or Peugeot. But time is running short (insiders claim PSA* will make an announcement at the Paris Salon at the end of September, while VW is set to tie up with Suzuki instead). The plant’s annual output is expected to eventually reach 200,000 units, thus doubling the company’s existing capacity in Thailand.
Toyota et al use countries like Thailand to source parts. One example is Japan’s U-Shin, which makes air-con and electrical system parts and will open a new USD21 million components factory in Thailand near its existing facility in Rayong within the next two years. Initially it will supply Suzuki's new assembly plant but it is also designed to supplant two existing factories in Japan which will be closed down.
Mark Apfel, president of GM Thailand and GM Southeast Asia Operations, says GM plans to increase annual purchases from suppliers in southeast Asia to as much as USD1.6 billion within three years; the bulk of the increase will be in Thailand. The parts will be used in Chevrolet trucks and cars produced in Rayong and at a new diesel engine plant being built there.
One pointer to a stable local auto industry is R&D. Thailand has hitherto lacked significant local expertise in developing new and, in particular unique products, although the next-generation Isuzu D-Max pickup will be engineered and designed in Thailand. It has long baffled observers that Bangkok has no overt desire for unique models, brands or 100 per cent IP ownership a la Malaysia or China, but this seems unlikely to change and Isuzu will be an exception to the rule unless Bangkok promotes R&D in a manner similar to the state authorities in Australia (Victoria and SA).
Some analysts had speculated that two months of anti-government protests in Bangkok might deter foreign investment in Thailand. But others say that Thailand, with its developed infrastructure, of which the most important element is a sufficient supply chain for JIT production, remains attractive to manufacturers – especially now factory workers in China are clamouring for higher wages.
Undeterred, carmakers are quietly interested in outcome of elections in Burma (a tasty potential market once unlocked, with Thailand in a good position to compete with another neighbour, China, because the latter doesn't produce pickups, which will be vital to recovery in Burma's agricultural and construction sectors) and even more interested in matters like the EIA situation around Rayong which looked likely until very recently to deter Ford from its USD425 million expansion.  BRT

*PSA Peugeot-Citroen

This article first appeared in Business Report Thailand, Issue 1, special focus report on 'Thailand's ASEAN Economy', October 2010.

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