Asia Pacific Economic Outlook:China, India, Philippines, Singapore

November 2010

Asia Pacific Economic Outlook — November 2010 2

China The topic of discussion in China today is the value of the currency. Like many other emerging countries, China is concerned about the effect of the new round of quantitative easing being undertaken by the US Federal Reserve. The fear is that this policy, by pushing down long-term interest rates and pushing up inflationary expectations, will cause significant downward pressure on the US dollar. As for China, it has long been engaged in a policy of holding down the renminbi against the dollar through foreign currency intervention. With the advent of the new US policy, a continuation of China’s strategy will likely require much larger intervention. That means more purchases of US dollar-denominated securities, more printing of Chinese money to pay for those securities and, therefore, more likelihood of Chinese inflation. The alternative, to allow the renminbi to rise in value more quickly, risks hurting the nascent recovery in China’s export sector. In other words, there are no easy choices for China.

Meanwhile, the People’s Bank of China, the country’s central bank, increased interest rates in October, the aim of which is to slow an otherwise overheated economy. Higher rates are supposed to curtail credit demand. Yet real (inflation adjusted) interest rates remain negative, so credit demand is not likely to be strongly influenced. Moreover, rising interest rates in China combined with low interest rates in the United States means that portfolio investment will probably continue to flow into China from abroad. That means that the money supply will continue to rise faster than the government wants. One way to offset this would be to allow the currency to rise in value more quickly. As discussed, the main reason that the government is averse to doing this is the impact it would likely have on exporters.

China’s currency policy, therefore, is at the heart of continued debate about the global economy. It is not limited to China. China’s policy is impacting countries in Asia and even emerging markets in other parts of the world. The countries of ASEAN (Association of Southeast Asian Nations) are reluctant to allow their currencies to rise lest their exports to China become uncompetitive.

Hence, many Asian countries now face the prospect of rising inflation and overheated economies as they print money to purchase dollars in order to hold down

the value of their currencies. Although these countries may be critical of the US policy of quantitative easing, the alternative is not especially attractive either. If the United

States fails to stimulate its own demand, Asian exports will suffer. A revaluation of China’s currency would allow other countries in the region to revalue as well without deleterious effects on export competitiveness.

Perhaps the biggest challenge is that China and other countries in the region continue to grow, in part, by exporting to the US consumer. Some officials in Asia want the United States to use fiscal policy to stimulate consumer demand. Yet this is not likely to happen. The United States, meanwhile, wants China to move toward consumer driven rather than export driven growth, especially in order to absorb exports from the United States. China is, in fact, moving in this direction and is allowing modest currency revaluation to take place.

The bottom line is that there is a debate taking place about currency policy. Despite the rancor, some good things are happening. First, China appears to be heading toward a soft landing with slower growth and more modest inflation. Second, China’s imports from the rest of the world are growing rapidly, thereby cementing China’s new role as an engine of global growth. Finally, China’s export sector is undergoing structural change with low wage factories moving inland and higher wage processes taking place along the coast.

IndiaThe cost of food continues to be the cynosure of both political and economic debate in India. The central bank is committed to reining in inflation and has raised its interest rate yet again. While the projected growth rate of about 8 percent for the current fiscal year is achievable, significant questions remain to be answered regarding growth in both the short and long term.

Inflation precipitates another rate hikeAlthough there is an indication that core inflation has fallen due to monetary tightening thus far, headline inflation rose to 8.6 percent in September. This is well above the central bank’s target inflation rate of 6 percent. Annual food inflation continues to be high; it was 13.8 percent for the week ended October 16. Policymakers are confident that inflation will fall to around the target level by December. Yet significant supply-side bottlenecks continue to exist in the agricultural sector.

The central bank is committed to ensuring sustainable growth and has concerned itself with controlling inflation

Asia Pacific Economic Outlook — November 2010 3

over the last several months. In its second quarterly review in early November, the central bank raised interest rates for the sixth time since March this year.

Industrial growth allows rate flexibilityIndustrial growth ticked upwards after months of lackluster performance. While the purchasing managers' index (PMI) rose to 57.2 in October compared to 55.1 in August, the uptick is likely seasonal. Given that consumer spending typically increases in the last quarter of the year, it could well be that the increase in the PMI reflects only an increase in inventories. The manufacturing sector grew 5.6 percent in August, and September’s figures are not expected to be stellar either.

Liquidity continues to be a problem in the economy. Although non-food credit growth has been along target levels, there is a shortage of liquidity in the economy. The quantum of growth in currency has outpaced growth in deposits, reducing the money multiplier. The recent rate increase will translate into higher lending rates in the short term; there is no reason to believe that increases will take effect immediately as banks have only recently hiked rates. Low liquidity and higher borrowing costs will affect those who manufacture for both the domestic and foreign markets. The export sector is already burdened with a rising rupee.

Productivity challengeIndia’s exports increased 23.2 percent in September on a year-on-year basis. Much of this momentum originated during the period from April to September, as exports grew 28 percent over the same period last year. Spurred by robust domestic demand, imports have grown at a slightly faster pace. Imports grew 26.1 percent in September and 29.9 percent for the period from April to September. This imbalance has led to an increase in the current account deficit; the deficit is projected to reach about 3 percent of GDP by the end of the fiscal year.

Given the volatile nature of short-term capital flows, the central bank has not normally been comfortable with a deficit of around 3 percent. Fortunately for India, there has been a surge in capital inflows in recent months; total inflow for the year is well over $20 billion. These inflows have helped finance much of the current account deficit. However, it must be noted that the liquid nature of the current inflows have been used to buy assets and are therefore quickly reversible. The benchmark equity index has risen close to the all-time peak it reached in January 2008. If, for any reason, the flow of funds should reverse, the current account deficit will become difficult to control.

The surge in inflows has also led to the rise of the Indian rupee. The rupee appreciated by about 9 percent in the last 16 months. This has made Indian exports costlier in the global marketplace. If the rupee continues to strengthen, exporters will be severely disadvantaged in a global market that is expected to grow at a slower pace in the coming months. The IMF has forecast global growth to drop from 4.8 percent in 2010 to 4.2 percent in 2011.

With a second round of quantitative easing expected, principally in the United States, more funds can be expected to flow into India. Thus, the Indian rupee is bound to keep appreciating. Despite the potential negative effects of a rising rupee, no intervention by the government or the central bank is expected in the near future. The central bank has also indicated that a further rate increase is unlikely in the near term.

Barring any internal or external shocks, the Indian economy is on track to achieve about 8 percent growth in the current fiscal year. However, the economy’s long term outlook hinges on the interplay of a few key factors. A faltering global recovery, the unabated rise of the rupee, a burgeoning current account deficit and a slowdown in the industrial sector are expected to exert significant downside pressure on the country’s long-term growth prospects.

7.50%

6.50%

5.50%

5%4.75%

5%5.25%

5.50%5.75%

6%6.25%

4.0%4.5%5.0%5.5%6.0%6.5%7.0%7.5%8.0%

Nov 08

Dec 08

Jan 09

Mar 09

Apr 09

Mar 10

Apr 10

Jun 10

Jul 10

Sep 10

Nov 10

Interest Rate (%)

Source: www.global-rates.com

Asia Pacific Economic Outlook — November 2010 4

PhilippinesAfter a period of moderate growth in 2009, the Philippine economy grew by more than 7.5 percent in the first two quarters of 2010. Riding on the strong recovery and renewed investor confidence, the Philippines will likely achieve GDP growth exceeding 7 percent in 2010. The main challenges for the government, however, will likely revolve around introducing land reforms, initiating policy changes to support economic growth and tackling corruption.

During the first half of 2010, election spending and increased remittances supported the strong recovery. Remittances from Filipinos living abroad constitute nearly 10 percent of the Philippines’ GDP and play a critical role in boosting domestic consumption and investment. With a large English speaking population, Filipino workers are in huge demand in developed countries as well as in the Middle East, primarily in the healthcare and personal care industries. Remittances are expected to remain strong in the latter half of 2010 through 2011, backed by the relative shortage of workers in countries with ageing populations, and the relative strength of economies in the Middle East and other emerging markets.

In recent months, Philippine exports recorded healthy growth. While Europe and the United States have been major markets for exports for many years, demand within the region has picked up; Singapore, Japan, China and Hong Kong are emerging as alternative export destinations. The semiconductors and electronics industry, accounting for two-thirds of Philippines’ exports, witnessed an unprecedented surge, recording double-digit growth in the first half of 2010. However, going forward, austerity measures in Europe and other developed nations may adversely affect export growth, posing significant downside risks.

Investment plans that were shelved during the economic downturn seem to have revived, a trend

likely to continue through 2011. As a result, domestic and foreign investment in various sectors including

telecommunications, mining, retail and real estate have recovered strongly after a lull in 2009. Increased private investments in residential properties also spurred a boom in construction

activity.

Several private companies have pledged higher capital expenditures in 2011 which may increase existing

capacities and stimulate growth in the services and manufacturing sectors. The Philippines is an attractive location for off-shoring activities given its skilled population; the country serves as an alternative to companies facing labor skill shortages and wanting to diversify away from India. As a result, the Philippines has benefited through increased foreign investment in the outsourcing industry.

Inflation is expected to pick up during the second half of the year. Furthermore, as the peso appreciates, the value of remittances erodes, leading to lower purchasing power. The central bank is expected to hike interest rates later this year if inflation inches beyond the 3.5 to 5.5 percent target range. However, the central bank will likely follow a cautious approach as raising interest rates too quickly may be counterproductive leading to further appreciation of the peso and lower domestic demand.

With the government focusing investments on infrastructure and social projects, the budget deficit may exceed the highs of 2009. The government aims to reduce the deficit to 3.3 percent of GDP in 2011, however, achieving that target seems ambitious. With a debt to GDP ratio exceeding 57 percent, a majority of it financed from abroad, maintaining a healthy fiscal situation is of paramount importance to the current government.Remittances may continue to remain a key factor supporting private consumption. Upgrading physical infrastructure, especially electricity generation, and implementing institutional reforms to deal with corruption will likely enable the country to grow faster. In the near term, the stability of the economy warrants a positive outlook. GDP growth near 5 percent in 2011 seems reasonable.

Asia Pacific Economic Outlook — November 2010 5

SingaporeFollowing two quarters of strong GDP growth, Singapore’s economy will likely moderate in the latter half of the calendar year. Although increasing at a slower pace than 2009, the economy will probably still benefit from the government’s loose fiscal stance and public expenditure in infrastructure. As inflation inches further ahead, the central bank is expected to keep monetary policy tight to help contain inflationary pressures. Steady growth in manufacturing and healthy domestic demand prompted the government to maintain its GDP forecast for 2010 at 13 to 15 percent. On the other hand, the possibility of sluggish growth in the United States poses downside risks and may warrant a revision of the growth outlook.

Singapore’s government announced that real GDP grew at a rate of 17.9 percent during the first half of 2010. A spurt in biomedical equipment manufacturing and electronics supported strong growth in the manufacturing sector. The services sector – mainly hotels and restaurants – recorded double-digit growth rates owing to higher tourist arrivals to the new casinos and resorts. The new casinos have also attracted a large number of local residents. Tourism and tourism-related industries are expected to register strong revenue growth as the casinos and resorts are likely to attract millions of foreign visitors.

Although a correction to GDP growth was anticipated after a robust performance during the first two quarters, weakness in the US economy and a sluggish recovery in Europe will have a big impact on external demand. Singapore’s labor and export-oriented industries would probably be adversely affected if global demand does not pick up significantly during the fourth quarter. China is currently Singapore’s third largest trading partner and accounts for nearly 10 percent of Singapore’s exports. Thus, moderation in China’s growth is a cause for concern for Singaporean exporters.

With an export to GDP ratio in excess of 200 percent, Singapore is heavily dependent on global demand. Singapore’s export cycle is showing signs of a slowdown with export growth figures for September 2010 significantly lower than August. Slower inventory restocking and a tapering off of growth in key export segments

contributed to the deceleration. Exporter woes are likely to continue as rising wages and a strengthening currency threaten to affect Singapore’s export competitiveness. While the pace of growth will likely be slower during the second half of the year, some export markets may well see a revival in demand.

Over the past six to eight months, Singaporean authorities have introduced several restrictions on the purchase and sale of real estate in order to dampen rising property prices. Residential property prices rose more slowly during the third quarter as compared to the second quarter, indicating some success for the government at controlling speculative activity in the property market. The construction sector contracted recently as building wrapped up on several new commercial and residential buildings. The government, however, appears to remain committed to easing supply constraints of residential property and is likely to free up more land for property development.

Compared to September last year, the consumer price index rose 3.7 percent, fuelled by higher costs of transport, food and housing. The central bank tightened monetary policy in October by steepening the currency trading band as well as resorting to widening the band. Although the policy stance is in line with the adoption of currency appreciation in April this year, the timing is unexpected. Allowing for faster appreciation of the currency may affect exports significantly. However, the central bank is focusing on reigning in inflation and aims to restrict inflation in the 2 to 3 percent band.

The outlook for Singapore is positive and firms in the services sector are upbeat about business expectations. Despite a slowdown during third quarter, employment has not been severely impacted and domestic consumption

has been strong. Economic conditions in the developed countries will, however, play a role in shaping the

export and investment sectors in the coming months.

Asia Pacific Economic Outlook — November 2010 6

About the EconomistsEditor

Dr. Ira KalishDeloitte ResearchDeloitte Services LPTel: +1 213 688 4765E-mail: ikalish@deloitte.com

Dr. Ira Kalish is Director of Global Economics at Deloitte Research. He is an expert on global economic issues as well as the effects of economic, demographic, and social trends on the global business environment.

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