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19 Jun 2006

Real Estate and Construction

Investment Trend, Construction: Sluggish 2006 through H1-2007

In the first quarter of 2006, investment in construction was still posting low growth of only 4 percent, the third consecutive quarter as this so far since the last half of 2005. Notably, in the first quarter, construction activity of the private sector decelerated quite significantly, growing only 2.8 percent; the lowest level in 6 years. Meanwhile, state sector construction activity was still able to grow moderately at 5.6 percent. The reason for the private construction deceleration was more than expected mainly stems from a slowdown in the housing market. A study by KASIKORN RESEARCH CENTER (KResearch) found that the impact of rising fuel costs for private vehicles and public buses this year may increase household expenses by totally around THB62 billion (around 1.5 percent of the total consumption spending value). This consequence may have also forced households to cut spending on goods that are not necessities.

KResearch forecasts that the trend for construction over the remainder of 2006 may still show the influence of negative factors. Demand in the real estate sector still faces major problems of oil prices and interest rates that may rise further in the third quarter, and may remain aloft until the last quarter. Moreover, political conflicts are still deteriorating confidence toward business expansion in the Thai private sector, as well as foreign investment. Meanwhile, political problems may also delay progress on the state's mega-projects and the passing of the annual budgetary appropriations for 2007. It is forecast that the deceleration of state investments in construction will become more evident in Q4/2006, just after the new fiscal year begins.

The factor that may send a positive effect on construction activities this year for condominiums and housing projects in the Bangkok Metropolitan Area (BMA) trying to expedite construction to avoid compliance with the new City Plan of BMA, which went into effect on May 17, 2006, and contain some details that will increase construction costs. However, this is still not likely to help boost construction activities substantially, overall.

KResearch forecasts that overall investment in construction may be valued at around THB693 billion in 2006, against THB657.484 billion in 2005, representing at fixed prices, growth of 0.7 percent, which is the lowest seen in 6 years. Private sector investment in construction may grow 4 percent (falling from the former forecast of 6-8 percent, as housing construction has decelerated more than expected), with an investment value of around THB357 billion, compared to THB327.395 billion in 2005. Meanwhile, postponement of budgetary spending for the new fiscal year may result in state investment contracting by 3 percent, where the investment value will be around THB337 billion, compared to THB330.089 billion in 2005. The higher investment value is the result of higher prices (a 'deflator'), but in quantity, there was a contraction in construction volume.

For the trend in 2007, private investment in construction may trend better due to the positive factor of weaker inflation following a slower pace in oil price increase, which may also continue have a moderating effect on the interest rate direction. Moreover, if political uncertainty recedes, it should help boost investor confidence. Under the above assumptions, it would be forecast that private construction could grow by 6 percent in 2007.

However, the recovery of private investment could face a major external risk factor from a potential US economic slowdown and their tremendous current account deficit, which would cause the world's financial and capital markets to fluctuate. In addition, if US domestic demand falls drastically, it could dampen Asian exports. As for the state sector, the first half of the year should see a steep decline in investment because of disruptions in government budgetary spending. The delayed approval of the Annual Budgetary Appropriation Act for 2007 will cause the state's construction expansion for 2007 to contract by 10 percent, and overall investment in construction in 2007 would grow at a negative 1.3 percent, posting the first negative growth in construction investment in seven years.

However, construction business could be revitalized again if the government's mega-project investments in infrastructure begin real progress after a new government settles in with stability. Growth in 2008-2009 is expected to be higher than 10 percent.

In 2006, construction costs will trend higher. KASIKORN RESEARCH CENTER expects that the Construction Materials Price Index will rise by an average of 4 percent this year, higher than the 0.0 percent of last year. Meanwhile, the Producer Price Index, and other costs may rise around 6-8 percent, lower than the 9.2 percent of last year. This may push overall construction costs higher, at a pace similar to last year. KResearch estimates that production costs will rise by about 4 percent over 2005.

This business volatility has occurred due to uncontrollable external factors such as market conditions and the cost of capital that are factors that construction related businesses should beware of. They will have to heed proper cost and liquidity management during this sluggish period. At the same time, they will also have to prepare investment plans and follow market trends closely in order to take advantage of the recovery of construction business in the future.

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