Rebalancing Growth in Asia

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Despite the sustained increase in oil prices in 2004, growth in Asia excluding Japan remained considerably resilient last year. Growth has indeed slowed down from the highs achieved in the first half of 2004 to a more sustainable rate as the economies enter a growth consolidating phase. Most importantly, economic fundamentals within the region continued to improve as economies slowly shift their reliance on export led growth to internally generated Asian demand growth. Much of this growth comes from China which has become the engine of growth for the region while levels of domestic demand in individual Asian economies are also benefiting from low real interest rates and appreciating currencies. While downside risks have recently increased from the relentless rise in oil prices, the simmering political tensions in North Asia and the onset of the US Federal Reserve tightening, these risks are manageable and are expected to have only a slight dampening effect on the region.

The one key risk that has a pivotal effect on the region's growth remains to be the continuing macroeconomic tightening in China. Per annum economic growth in China was brought down from almost 10 per cent in early 2004 to 9.3 per cent in the second half of 2004 while CPI inflation slowed from over 5 per cent in the middle of last year to around 2 per cent in January 2005. However recent data releases suggest that there remain some sources of overheating that are not yet under control while inflation expectations may not have been fully contained, as CPI inflation jumped back up to almost 4 per cent in February. The Chinese authorities have grown increasingly concerned over a possible property bubble in the making across major Chinese cities, especially in Shanghai where property prices grew by 10 per cent in 2004 after growing by almost 29 per cent in 2003. In response to these concerns, the People's Bank of China, which has already raised the benchmark loan rate by 27 basis points in October last year, increased the home loan down-payment ratio from 20 to 30 per cent and further raised the housing loan rate from 5.31 to 6.12 per cent in mid March. While the result of this latest efforts to cool China's overheated sectors remains to be seen, preventing an asset bubble is likely to be the key challenge for the Chinese authorities in the coming year as pressure for the Renminbi to appreciate continues. Assisted by the weak US Dollar, Chinese exports have shown renewed signs of strength in the latest data releases, we expect growth in China to remain strong at 8.9 per cent in 2005 before slowing down to around 7.5 per cent in 2006. This forecast does not factor in any revaluation of the Renminbi in the near term but expects both the export sector and domestic demand to continue to support the economy.

Barring any hard landing in China, growth in the region is expected to soften slightly in the next two years compared to last year with growth in the newly industrialised economies (NIEs) growing at around 5 and 4 per cent in 2005 and 2006 respectively. This forecast is based on the assumption that the recent appreciating trend in Asian currencies, which saw the New Taiwan Dollar and South Korean Won appreciating by 4.1 and 6.5 per cent in the first quarter of this year compared to the previous quarter, will continue. We remain optimistic that this consolidating phase over the next two years would set the stage for the rebalancing of growth from the export sector to the domestic sector, especially for the NIEs. Asian policy makers should take this opportunity to accelerate the evolution of the Asia economic model such that advancement in the domestic knowledge based sectors especially the financial services sector could release the region from its current reliance on the de facto peg to the US dollar for growth and stability. The evolution of the Asia economic model and its impact on global realignment of exchange rates are discussed further in Al-Eyd, Barrell and Choy (2005). …