September 04, 2006	Monday	Sha'aban 10, 1427

South Korea

Stronger consumption growth and an improved export performance deepened the economic recovery in the first quarter of 2006. These factors are expected to push GDP growth to 5.1 per cent for the year, despite anaemic growth in investment. Given the real won appreciation against the US dollar of about seven per cent from January through June 2006—following gains of about 26 per cent between 2002 and 2005—and a rapid growth in imports, especially oil, the current account surplus is likely to decline sharply. Although inflation rose to 2.6 per cent in June 2006, and could further increase marginally during the second half of the year - as cigarette taxes and public utility rates are expected to rise —the Bank of Korea recently lowered its inflation forecast for 2006 from three per cent to 2.6 per cent.

While headline performance has improved, the composite leading indicator suggests a possible loss of momentum. In addition, higher oil prices could reduce profit margins, particularly in the export sector, which is also pressured by a rising won and increasing wages. A disorderly adjustment of the global payments imbalance could exacerbate these trends and erode export demand. Domestically, a possible sharp correction of the real-estate boom could weaken spending by heavily indebted households, reduce construction activity, and increase NPLs in the banking system.

Inflation has been maintained within its medium-term target range of 2.5–3.5 per cent, helped by won appreciation that mitigated the pass-through effects of higher imported fuel costs. In addition, further improvement of the fiscal balance, which moved into surplus in 2005, is expected this year. Future policy actions should weigh the possibility of re-emerging inflationary pressures—if oil prices continue to climb or the May–June currency weakness persists—against the risk of a softening economic recovery.

Structurally, investment is constrained, in part, by problems in corporate governance, recently demonstrated by high profile government cases against both domestic and foreign firms and by labour market rigidities. As property prices are rising rapidly in some locations, bank loans for household mortgages and small business loans backed real estate collateral require close monitoring. South Korea’s industrial production probably fell by the most in five months in July as strikes at automakers such as Hyundai Motor Co. curbed production and heavy rain kept people from spending at retailers. Manufacturing probably fell 3.1 per cent last month from June, when it gained 1.2 per cent, seasonally adjusted. Export growth probably accelerated in August as car shipments picked up following the end of a month-long labour strike at Hyundai Motor Co.

Consumer prices likely gained by the most in five months. The improvement in the trade position may not endure as global interest rate increases threaten to damp demand for the nation’s exports, which account for 40 per cent of the economy. South Korean’s inflation likely accelerated in August, with unadjusted consumer prices rising 0.4 per cent from July, according to the economists’ survey. Prices probably climbed 2.4 per cent this month from a year earlier, compared with a 2.3 per cent annual increase in July. The central bank raised its benchmark interest rate to a five-year high of 4.5 per cent joining central banks in Europe and Asia that are grappling with accelerating inflation. The Bank of Korea aims to keep prices between 2.5 per cent and 3.5 per cent. On top of the rain damages, rising oil prices probably stoked inflation in August. The price of Dubai crude oil, South Korea’s benchmark, gained 24 per cent this year. The country imports almost all of its oil, making it the world’s fifth- largest oil importer.

South Korea’s economy expanded 0.8 per cent in the second quarter from the first, its slowest pace since the first three months of 2005, as consumer spending cooled and construction fell, the central bank said. Consumer confidence fell to an 18-month low in July, adding to evidence that rising oil prices and higher interest rates are damping growth in Asia’s third-largest economy.

The BOK’s expectation that economic growth will ease in the remainder of 2006 suggests that further rises in the call rate are unlikely in the short term. Real GDP will grow by 4.9 per cent in 2006 and 3.9 per cent in 2007. Domestic demand will firm over the forecast period, largely reflecting the recovery of private consumption. The outlook for construction remains uncertain, however. The won will continue to appreciate, helping to contain inflationary pressures. The current-account surplus will narrow as merchandise trade surpluses are eroded. The BOK announced that it would switch its inflation target from core inflation (excluding oil and agricultural products) to headline inflation. This suggests that monetary policy will henceforth be more sensitive to volatility in global commodity prices.

Despite the increase in economic growth in early 2006, considerable uncertainty remains in the economic outlook for Korea. Korea’s economy is particularly vulnerable to higher world oil prices. A significant increase in world oil prices has adversely affected consumer confidence. However, according to some economists, economic growth in Korea is assumed to be around 5.0 per cent in 2006 and 4.7 per cent in 2007. This compares with growth of 4.0 per cent in 2005.

On the other hand, the South Korean Finance and Economic Minister says that the country’s economic growth will slow to a mid-four per cent level in 2007 from this year’s targeted five per cent gain.

China

China is the new frontier of growth in the global economy. Strong economic performance in China has provided support for growth in neighbouring and regional countries, including the Republic of Korea, Chinese Taipei and south East Asia. In other parts of the world, markedly higher prices for energy and mineral resources have provided benefits to economic activity in Latin America, the Middle East and central Asia. Its economy is expected to grow 9.3 per cent this year and 8.8 per cent in 2007, as overcapacity in some sectors starts to affect economic growth, according to an official forecast.

Economic growth in China strengthened in early 2006, despite attempts by China’s government to slow economic activity to a more sustainable pace during 2005. Gross domestic product, the broadest measure of economic activity, reached 4.33 trillion yuan (about US$540 billion) in the March quarter 2006. Despite the significant pace of economic growth, the consumer price index rose year on year by 1.2 per cent in the same quarter, compared with an average increase of 1.8 per cent in 2005.

The significant economic growth in the March quarter 2006 was driven mainly by higher investment. Investment spending on roads, factory equipment and other assets was around 1.39 trillion yuan (around US$173 billion), a sharp increase of 28 per cent from the December quarter 2005. Investment in urban areas increased by 30 per cent to 1.16 trillion yuan (US$145 billion), while that in rural areas reached 230 billion yuan (US$28 billion), up by 18 per cent. In order to narrow urban–rural income inequality, China has recently launched a ‘Socialist New Countryside’ campaign to increase rural investment and development.

Investment opportunities in China remain one the greatest of the 21st Century. In a country of 1.3 billion people, with annual GDP growth twice that of the US (in the seven to nine per cent range), it is clear that there’s no stopping China’s launch as a major player in the global economy. Investors who ignore the China opportunity will certainly be left behind as the economy continues to excel and new companies capitalizing on the opportunity soar to new heights.

The strong economic performance in early 2006 has raised concerns that China’s government will take more stringent measures to moderate economic growth in the short term. China is the world’s largest consumer of steel, copper and many other mineral resources and the second largest consumer of crude oil. A significant slowdown in economic growth in China, if it were to occur, would have important implications for world economic growth and commodity prices. The emergence of China as a major world economy has attracted significant attention in recent years. Nowhere has China’s growing economic influence on the world economy been felt more significantly than in world commodity markets.

Incomes: Per person incomes have been rising rapidly in China, leading to a significant increase in consumer demand. According to the Chinese Academy of Social Science (CASS), China’s middle income class grew from around 15 per cent of the population in 1999 to around 19 per cent in 2003. CASS projects that China’s middle income class will increase to around 40 per cent of the society (or around 587 million people) by 2020. Such an increase in China’s middle income class, if it is achieved, will lead to a significant increase in consumer demand in China.

Despite the strong economic growth achieved in recent years, many economic commentators forecast that economic growth in China will ease, but not significantly, in the remainder of 2006 and 2007. But China’s booming economy grew 10.2 per cent in the first quarter, picking up from last year’s already breakneck pace to spark a fresh warning the pursuit of growth for its own sake could lead to problems. The expansion in the first three months, announced by the National Bureau of Statistics, came on the back of massive increases in investment in factories, bridges and other fixed assets.

The country’s economy expanded 9.9 per cent in 2005 and the government, hoping to switch the focus to domestic consumption away from exports, had earlier set a more modest. Last year, the economy appeared more dependent on manufacturing, which made up 47.5 per cent of GDP with farming and affiliated operations contributing 12.6 per cent. Chinese leaders have warned repeatedly that rapid growth could ignite inflation or leave the country littered with unneeded factories and luxury apartments, causing problems for banks that financed them.

The government target for this year is eight per cent growth, though forecasts by outsiders range as high as 9.5 per cent. The economy expanded by 9.9 per cent last year. Amid their warnings, Chinese leaders need to keep the economy surging to replace millions of jobs lost in layoffs at state industry. And the government needs the tax revenues to pay for ambitious plans to develop the poor countryside.

At the same time, China has piled up the world’s biggest foreign reserves, which the central bank says have reached US$875.1 billion (euro723 billion). Most is invested in the US Treasury bonds. A state newspaper quoted a deputy chairman of China’s parliament, Cheng Sewer, as saying the government should reduce the amount of Treasuries it buys. He said China should channel the money into buying more US goods, which would cut its politically sensitive trade surplus. The country has been experiencing large trade surpluses with the United States and the European Union. In April 2006, China recorded a monthly trade surplus of US$10.5 billion. This compares with an average monthly surplus of US$8.5 billion in 2005.

China’s strong trade performance has continued to lead to significant international pressures for a substantial revaluation of its currency. In July 2005, China changed its foreign exchange regime from ‘pegging’ to the US dollar to the so-called ‘managed’ float. After the announcement, China’s currency appreciated by 2.1 per cent against the US dollar (from 8.28 to 8.11 Yuan).