The Hindu Business Line : Year of the Asian zoom

Asia's growth has gained considerable momentum in recent quarters, with the region benefiting from a surge in external demand for electronic products. The IMF's Asia-Pacific Regional Economic Outlook provides a synopsis of the strengths and weaknesses of the region and the risks to the sustenance of its continued economic boom, says G. SRINIVASAN.

The International Monetary Fund (IMF) through its Asian Department, released its Asia-Pacific Regional Economic Outlook (REO) report in Washington on May 1. The report provides a synopsis of the strengths and weaknesses of the Asia-Pacific region and the risks to the sustenance of the region's continued economic boom. At the outset, the Fund contends that this year should be another salutary one for Asia. Growth for the region is forecast at 7 per cent, the same as in 2005.

The IMF says Asia's growth has gathered considerable momentum in recent quarters, with the region benefiting from a surge in external demand for electronic products, which has stimulated investment, employment and consumption in most economies. While growth is likely to moderate in China and India, this merely signals "a return to more sustainable — but still very robust levels," the Fund says, adding that real growth year-on-year in India was 7.4 per cent in 2004, 8 per cent in 2005 and a projected 7.3 per cent in 2006 and 7 per cent in 2007.

It says growth in the second half of 2005 in China and the newly industrialising economies (NIEs) of East Asia was over 2.25 percentage points higher than expected earlier, with India and Japan providing "positive surprises" as well.

Electronics boom

The strong growth momentum derives in large part from a booming demand for electronics, which account for one-third of the region's exports. The IMF says global demand for all lines of electronics surged in the summer of 2005 and remained buoyant since, helped by a confluence of factors: A wider offering of high definition TV programming by cable companies helped boost sales of flat-screen TV sets and other ancillary products; phone companies' improved network coverage for 3G wireless released pent-up demand; MP3 players became the mainstream choice for music playing, both portably and at home; and major companies went digital as photography's technology of choice.

The report also points out that emerging Asia's exports would also benefit from developments within the continent. Illustrating this, it says China's imports are gaining momentum, growing at an annual rate of 25 per cent in the first quarter of 2006 relative to the same period last year, compared with 22 per cent in the fourth quarter of 2005. While a large part of these imports are processed and then re-exported to third markets such as the US, China's role as a source of final import demand is growing. Mobile handset-maker Nokia expects China to add 250 million mobile phone subscribers by 2010, while sales of flat-screen TV sets — many of them made outside China — are estimated to have risen by close to 200 per cent in 2005. China has now surpassed Japan as the third largest market for this product.

Rising oil prices

Notwithstanding this generally favourable picture, the Regional Economic Outlook says that significant risks remain. Prime among these is that of higher oil prices. Rising oil bills have so far had only a moderate effect on Asia's growth, but this may change, especially as concerns about future supplies — rather than unexpected increases in demand — have become the prime mover of prices. Without specifically adverting to India, the Fund cautions "higher oil prices could also intensify inflationary pressures, particularly in countries where domestic prices remain below world levels, necessitating further large administered price adjustments." Citing IMF staff estimates, it says that GDP growth in Asia might decline by 0.75 percentage points for every $10 per barrel increase in the price of oil, merely from the direct effects of the increase. Since oil prices increased by roughly $30 per barrel, the impact could have been three times larger.

Global financial conditions

A second risk arises from the tightening of global financial conditions. So far, the region has benefited from a benign environment of low long-term interest rates in the US and low risk aversion, which have fuelled declines in Asia's bond spreads and increases in its equity prices. As the global environment changes, however, Asia's financial markets and mettle will be sorely tested.

However, the Fund hastens to mention that the region should be able to weather such disturbances, since in sharp contrast to the mid-1990s, asset prices are not markedly over-valued and external vulnerabilities are relatively low. It further states that though banking soundness in Asia has improved, banks in some countries have encountered rapid growth of credit to households, and that close supervision is called for.

Yet another factor is that global imbalances pose another risk, but probably not in the short term. The US current account deficit is projected at 6.5 per cent of GDP in 2006, about the same as last year. While a disorderly adjustment to global imbalances seems unlikely in the immediate future, a sharp slowdown in US demand would have significant consequences for Asia, which remains highly dependent on external demand.

Three key issues

In this milieu, the Fund says there are three key issues for macroeconomic policy-makers. First, central banks would need to engage in a delicate balancing act, maintaining a monetary stance firm enough to deal with the inflationary pressures arising from high oil prices, without imperilling the recent improvements in domestic demand.

Second, some governments need to bolster their fiscal positions, reducing their debt, while fostering the fiscal space needed to meet the costs of population aging and upgrading public infrastructure.

Third, governments would need to invigorate domestic demand, to underpin growth while reducing external imbalances.

Relevance of RTAs

The Regional Economic Outlook also poses the relevant query whether the regional trade agreements (RTAs) in Asia open or close blocs?

The report says it is useful to ask whether the recent proliferation of preferential agreements in Asia is a healthy development or whether it will result in an unmanageable "noodle bowl" regionalism in the future, more likely to divert trade than to create it.

It says the recent trend towards negotiating and signing multiple bilateral trade arrangements, including between ASEAN and the major Asian economies, could threaten the multilateral trading system, if regional integration is perceived as a substitute for multilateral liberalisation.

Hence, the Fund urges Asian countries to persist with pursuing concerted trade liberalisation in accordance with the MFN (Most Favoured Nation) principles, rather focusing on regional trade preferences only. In particular, countries should guard against participation in multiple memberships in bilateral and regional trade pacts, which could have mutually inconsistent rules of origin that could substantially complicate production and sourcing decision by firms.

This is a serious issue the authorities should keep in view considering the litany of woes voiced by domestic industry about multiplicity of rules of origin confusing it and rendering its cost calculations awry.

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