June 26, 2006	Monday	Jumadi-ul-Awwal 29, 1427

The global economy will maintain moderate growth in the region of three per cent between 2005 and 2010. The US economy will continue to grow at around its potential growth rate, and the economies of Asia will grow driven by the Chinese economy. Although the US will remain an engine of global economic growth, it will not “reign supreme” as in the 1990s. Instead, it will be joined by Japan and the EU as they emerge from malaise and their recoveries gather pace, and by the BRICs and other emerging economies, which are projected to enjoy sustained high growth throughout the period. Global economic growth will thus become increasingly clearly multipolar in nature.

One risk factor that could cause global growth to stall is the steep rise in the price of primary commodities and other raw materials. In particular, oil prices are expected to rise even more sharply in 2006 due to seasonal factors. The rise in crude oil prices will then settle down due to the slowing of global economic growth, but in the medium term as well, oil prices are projected to hover at a high level due to growth in demand in emerging economies. Developing countries are now more resistant to the effects of sharp rises in oil prices than at the time of the oil crises thanks to improvements in energy efficiency. Nevertheless, escalating oil prices will still squeeze corporate earnings and consumers’ disposable incomes. In developing countries, where energy efficiency is lower, escalating oil prices could trigger inflation. In countries that are dependent on imports for oil supplies in particular, there is a risk of economic turmoil arising from a drop in currency value as their balances of payments worsen.

The US economy continues cruise despite presence of risks. There is little likelihood that the US will experience a serious downturn stemming from the inventory cycle, as the industrial structure is growing increasingly service oriented, as evidenced by the fact that tertiary industry accounted for approximately 80 per cent of GDP in 2004, and advances are being made in inventory control driven by the adoption of IT. The US economy is therefore projected to register stable growth despite the presence of risk factors, including the possibility of interest hikes to head off inflation arising from escalating oil prices, and the collapse of the housing bubble.

Regarding the risk posed by oil prices, the present rate of increase is modest compared with at the time of the first oil crisis in 1974 (283.9 per cent) and the second oil crisis (130.8 per cent). Rises in the consumer price index and interest rates are also more limited. For example, the combined CPI rose 11.0 per cent in 1974 and 11.3 per cent in 1979, compared with 3.8 per cent in the third quarter of 2005. The short-term (Federal Fund) rate reached an annual average of 10.4 per cent in 1974 and 11.2 per cent in 1979, but is presently (as of November 2005) just 4.0 per cent. However, the Federal Reserve Board (FRB) is adopting an increasingly cautious stance toward inflation, and monetary policy may be tightened to curb inflation if inflationary pressure grows further.

Up to 2010, the Chinese economy will enjoy continued high growth, despite a slowdown in export growth (the engine of rapid growth in the first half of the decade), led by growth in areas of domestic demand such as personal consumption and fixed asset investment, and China will occupy an increasingly important presence as the engine room of growth in the Asia region. Growth in exports will slow due primarily to two reasons. Firstly, overseas pressure to revalue the yuan is expected to continue, and the price competitiveness of Chinese products will decline as the currency appreciates. And secondly, foreign companies will disperse their production operations to other regions outside China in response to rising production costs there, causing growth in inward foreign direct investment to decelerate. Personal consumption, on the other hand, is projected to register firm growth due to improvements in income levels and consumer sentiment.

Fuelled by the high level of economic growth, demand for oil is growing rapidly (rising by an annual average of 8.6 per cent between 2000 and 2004, compared with worldwide growth of 1.9 per cent), and this is believed to be one of the main causes of the recent sharp rise in oil prices. Although China’s energy efficiency is improving, it remains low by international standards. Demand for oil is expected to continue to swell as the Chinese economy grows, but improving energy efficiency by 20 per cent by 2010 has been adopted as a target of the 11th five-year plan, and measures to protect the environment and save energy are also likely to be pursued.

In the NIEs and ASEAN, domestic demand will be depressed by the continued steep rise in oil prices. In ASEAN countries such as Thailand, Malaysia, and Indonesia, where energy efficiency is low and dependence on oil as an energy source is high, the economic impact of high oil prices will be particularly considerable, and act as an inhibiting factor on growth. Up to 2008, exports to the U.S. will grow more sluggishly as the U.S. economy slows. Exports to China, on the other hand, will grow, enabling exports to grow strongly overall, bolstering the NIEs and ASEAN economies. From 2009, the slowdown of the Chinese economy will cause growth in exports to China to slow, but as exports to the US will rise, the downturn in business conditions is projected to be limited.

The EU is to experience modest growth The UK and French economies are likely to continue to experience firm growth led by growth in domestic demand. The German and Italian economies, which performed sluggishly in the first half of the decade, will begin to recover as exports grow in response to improved corporate profitability generated by structural reforms to the labour market. As Germany’s general election in September 2005 failed to produce a single-party government formed by the reformist opposition party, the speed of structural reform in Germany is likely to be slow. The recovery in Germany-the EU’s largest economy-will therefore be only gradual, and economic recovery in the EU as a whole is expected to take some time.

The US and the EU, which each account for around 30 per cent of the global economy in terms of nominal GDP, will experience healthy growth, and Japan too, which accounts for around 10 per cent, will follow a recovery trend as measures to overcome structural problems since the collapse of the bubble economy have progressed. The BRICs (Brazil, Russia, India, and China), which economically are almost as large as Japan (together accounting for 8.6 per cent of global nominal GDP in 2004) and have exceeded growth in the NIEs and ASEAN since 2000, will maintain high annual real GDP growth of 6.7 per cent for the duration of this forecast.

Asian economic outlook

Outlook for the Asian region remains positive, with solid economic growth expected to continue at least through the end of our forecast period in 2008. Although this business cycle has been characterised by unusually low inflation, the Asian inflation will continue to track upward. The commodities have rallied strongly with this business cycle for two main reasons. First, low inflation across the developing world has allowed GDP growth to translate into household wealth, boosting energy demand. Second, low interest rates have spurred infrastructure investment, which in turn requires both energy and base metals inputs. The pass through of high commodity prices was dampened in Asia in 2004/2005 by government subsidies, but these are being steadily wound down.

Energy demand is expected to persist. Forecasts indicate that the GDP per capita will exceed US$10,000 across Asia, Europe and Latin America within the next five years. The US$10,000 threshold is the benchmark used by the World Bank to separate “low-income” from “middle-income” countries. For example in China, the largest developing economy, greater household wealth has generated “motorisation” and rising petrol demand. Base metal demand, on the other hand, has been driven by high investment. Gross fixed capital formation has been China’s primary growth driver over the past decade.

The major risk for Asia this year is that inflation expectations are going to rise faster and for longer than policy makers currently anticipate, and that central banks will have to continue to raise rates and actively reduce liquidity. This would force most Asian economies to slow and certainly lead to a more negative growth outlook than most observers expect at present. After experiencing inflation in excess of 17 per cent in recent months, Indonesia should buck the regional trend this year and experience declining inflation and interest rates. By end-2006, policy rates should be nearly back to where they were at this time last year, before Bank Indonesia had to aggressively raise interest rates to deal with inflation spikes arising from a dramatic reduction of fuel subsidies.

While growth in 2006 is likely to be lower than currently forecast by the government due to weak consumption, the structural reforms being implemented by the new economics team set the stage for a period of higher productivity growth and lower inflation in Indonesia over the longer term. Inflation in Thailand could become a larger problem than is currently anticipated in consensus forecasts. The political turmoil is expected to last for at least several months as there is no clear successor to the Thai Rak Thai party, which held 377 out of 500 seats in the outgoing Parliament.

With all the uncertainty and weak sentiment, politicians will be tempted to once again loosen the purse strings and bring back “Thaksinomics” to reinvigorate domestic demand. There is, however, little room to do so as total public sector debt has climbed to over 50 per cent of the GDP.