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How to repel the inflation invasion in Thailand

Frederico Gil Sander's picture

Price increases continue to make headlines in Thailand. Inflation in April was the highest in 15 months and, despite some respite from oil markets, the worst may not be over since many prices remain controlled to some extent. In my last entry, I discussed why inflation has been hard to tackle: it comes mostly from external sources, it doesn’t hurt everyone and it may be driven by long-term trends. So what can be done about the inflation challenge?

 

As a World Bank economist, I tend to focus on policies that would help in the long-term: (1) develop systems to identify those who are hurt the most by higher food prices and provide them with cash transfers so they maintain healthy levels of food consumption, (2) increase energy efficiency to reduce demand for fossil fuels, and (3) boost agricultural productivity and invest more in water management and agricultural research to build resilience against climate change, ensuring a larger and more stable food supply. 

 

The monetary policy of the Bank of Thailand (BoT) is also most effective beyond the short-term. Excessive demand is not the main cause of rising prices (at this time) and the economic recovery still requires some (reduced dose of) monetary policy medicine. This means that hiking interest rates quickly is unlikely to help. The actual policy adopted by the Bank of Thailand - steady but gradual rate hikes - signal that the central bank will not allow future inflation to go unchecked, but could do nothing to stop the sharp increase in egg (and other) prices in April.

 

Governments in Thailand and elsewhere in the region, however, do not have the luxury of focusing on the medium- and long-term, and undertook a combination of measures to keep a lid on prices. In Thailand this included fertilizer and street food subsidies but, most prominently, a subsidy (later replaced by a tax cut) for diesel fuel.

 

Diesel is very important for the transportation of both people and goods (including food), so keeping diesel prices contained helps hold back price increases more generally. It must also be said that the subsidy does not jeopardize Thailand’s long-term fiscal sustainability. The fiscal deficit in 2010 was lower than expected, and tax revenues this year may still come in line with earlier (conservative) projections even when the recent cut in excise tax for diesel is taken into account. 

 

Although the diesel subsidy makes some sense as a short-term response, there are significant concerns when you take a long-term view:

- First is the issue of incentives for energy conservation. To reduce vulnerability to higher oil prices, Thais need to use less energy. The World Bank April 2011 Thailand Economic Monitor (full disclosure: I'm the author) argues that (.pdf) one important tool for increasing energy efficiency is to raise fuel taxes. If diesel is underpriced, people drive more.

- The second concern is that subsidies will eventually have to be removed if fiscal sustainability is to be maintained, which could lead to a sharper spike in inflation.

- Finally, the benefits of this large expenditure item are not targeted to those who need it most. Economists at the IMF have estimated (.pdf) that 65 percent of the benefits of diesel subsidies go to the richest 40 percent of the population. This actually relates to my experience: the main beneficiary of the subsidy that I know is a friend who drives a diesel-powered BMW…

 

Reconciling long-term and short-term goals is not an easy task for any government. One possibility is to gradually increase the excise tax while redirecting those resources towards increasing agricultural output (for example through limited fertilizer subsidies), or existing social insurance schemes, such as the 500-baht pension for the elderly. Another option is to rely more on interventions where self-selection leads to better targeting. For example, the beneficiaries of the free non-air conditioned buses have been primarily low-income earners. 

 

What do readers think the government can do to help with inflation in the short-term, without losing sight of the long-term goals?