Risks in the wind, but outlook strong - Asian economic recovery - Brief Article

Business Asia, May 19, 2000

Higher US interest rates are a worry, but PAUL BRENNAN(*) suggests Asia's strong rebound will continue

Helped by a recovery in capital inflows, robust US demand and the production rebound in information technology, the recovery in Asia continued to develop and broaden during 1999.

Underlining the rebound, the region recorded economic growth of 6.3 per cent.

At the same time, deflation fears receded. South Korea, China, Taiwan, Singapore and Malaysia were the brightest stars in 1999. Only in Indonesia was the economy flat, although the recovery was weak in Hong Kong and the Philippines.

Another solid year is expected in 2000, with economic growth accelerating slightly to 6.7 per cent.

Only a moderate pick-up in inflation is projected to around 2.6 per cent as spare capacity in Asia is gradually eroded. Inflation could become more of a threat next year, especially in Korea.

Australia is benefiting from the stronger-than-expected recovery in Asia.

Our exports to Asia have risen 27 per cent in the past 12 months, with particularly rapid growth to Singapore and China.

However, a number of risks and opportunities are worth highlighting. Our Asian economic team, writing in the May edition of "Asian Outlook and Strategy", commented:

"The global environment facing Asia has become more choppy, with the prospect of higher US interest rates and more equity market volatility clouding the picture, but faster global GDP growth brightening it.

"The bad US inflation figures are most worrying, as they indicate a larger risk of a hard landing in the US. Asia, though, has three insulators that should help its economies and assets outperform: better growth prospects for Japan and Europe, strengthening intra-regional trade and more flexible exchange rates.

"The prospect of higher US interest rates, along with a generally faster pace of import recovery than we had earlier expected, means somewhat weaker currencies in Asia.

"We have lowered our won, baht and rupiah forecasts (versus the US dollar). A weaker Euro prognosis impacts most directly on our view of the Singapore dollar versus the US currency.

"The Asian markets' fall over the past month has been a knee-jerk reaction to the sharp pullback on the Nasdaq. With Asian indices heavy on technology and telecom stocks, the falls have looked particularly acute. Having experienced a period of extreme volatility, it must be reasonable to expect that investors have become more risk-averse. On a six- to 12-month view, we are optimistic on the equity markets. Since the fourth quarter of 1999, this region has been in a phase of its market cycle that is driven by growth.

"During this phase of the cycle, periodic (equity market) sector rotation is also a feature. The trajectory of the markets' rise is, therefore, less even and there will be occasional setbacks. But as long as growth prevails over rising interest rates, a bull market should continue. On this basis, a strategic bias in favour of growth still seems justified."

Overall, while we recognise that higher interest rates in the US create new risks because of the sensitivity of some Asian markets (especially Hong Kong and Singapore) to rising interest costs, we remain positive on the economic and financial outlook in Asia.

In 2001, we forecast another year of plus 6 per cent economic growth.

The announcement this month of the establishment of an Asian regional financial arrangement, which would significantly expand the web of bilateral swap arrangements between central banks in Asia, has the potential to improve the structural integrity of the Asian countries.

[*] Paul Brennan is an economist for Salomon Smith Barney / Citibank.