Reversal of Fortune for Bangkok; Southeast Asia gets whipsawed by global money flows

August 20, 2013, 12:36 p.m. ET

Reversal of Fortune for Bangkok

Southeast Asia gets whipsawed by global money flows.

The land of smiles is not in a cheerful mood. Second quarter data out of Thailand on Monday showed that the economy contracted for a second time on a quarter-on-quarter basis, which was worse than expected and puts it technically in recession. The government has cut its growth forecast for the year to a range of 3.8% to 4.3% from its previous estimate of 4.2% to 5.2%. The main stock index dropped 3.3% on Monday and 2% on Tuesday.Thailand is a useful case study for Southeast Asia, as it suffers from the same malaise that has hit its neighbors. A year ago it was a favorite with investors and posting healthy growth, so what happened?

One explanation is the slowdown in external trade, especially with the Chinese economy. Beijing’s post-2008 stimulus led to a construction boom that benefited Southeast Asia. That has now run out of bank credit, and while China officially continues to grow at more than 7%, Beijing’s data are highly suspect. Proxy indicators such as electricity use suggest Asia’s main engine of growth is sputtering.

Also like its neighbors, Thailand is a victim of the global tsunamis of money unleashed by the U.S. Federal Reserve. A year ago as quantitative easing was the order of the day, the Bank of Thailand was faced with an economy that seemed on the verge of overheating with 6.5% growth for the year, yet it dared not raise rates as foreign investment flooded in and the baht strengthened.

Now that Fed tapering is the new theme, Thai central bankers face the opposite dilemma as they meet Wednesday. The domestic economy could use a boost, but the baht is weakening. The easy money of the past few years has also resulted in a run-up in household consumer debt. So the BOT will probably leave rates unchanged.

The good times also made it possible for politicians to indulge in a bout of spending. The reconstruction from 2011’s flooding was largely justified, although some waste crept in. The government tried to goose consumption with subsidies, for instance for first-time car buyers. The biggest problem is the rice-pledging scheme by which Prime Minister Yingluck Shinawatra‘s government pays farmers 50% more than the market price for grain.

Officials claimed they would corner the world market and sell at a profit. Instead, other rice-growing countries stepped up their production and stole Thailand’s crown as the top exporter. Now the rice is sitting in warehouses and will soon rot if not consumed. The World Bank predicts the program will lose up to $5 billion annually.

That feeds into concerns about weak governance in the region. As John Kurtz and James Van Zorge of A.T. Kearney wrote in these pages last week, Indonesia is paying a price for hubris during the boom. Jakarta indulged in resource nationalism, squeezing foreign mining companies. Now the commodities boom is at an end or at least on hiatus, and the lines of investors waiting for project approvals have evaporated. Reforms are needed to shore up Indonesia’s reputation as a predictable jurisdiction for investment.

Southeast Asia must also contend with the perennial questions about political stability. Rumors of a coup flew in Bangkok a few weeks ago, leading the police to detain several people for their Facebook posts. Prime Minister Yingluck’s party tabled a bill to amnesty those who committed crimes during the civil strife since 2006, and that has royalists on alert to stop her brother, former Prime Minister Thaksin Shinawatra, from returning from exile. Some investment is on hold, waiting to see how this plays out.

The lesson for Thailand and its neighbors is the familiar one that they need to tread a careful path among the great powers. Since they can’t avoid being whipsawed by U.S. and Chinese policies, the best recourse is to put their own houses in order so investors won’t panic when the money flows reverse direction.