A year for cautious optimism

Photo: AFP

As usual the fortunes of the US economy will dominate the outcome of global economic performance. It would be good to see in the US, a growth train moving firmly forward on its rails, without much help from continued short term policy stimulus. China also is likely to dominate headlines as its remarkable growth and policy towards its currency will be closely watched. Creeping trade protectionism against China by the US could gain momentum, causing retaliation from both sides. Europe and Japan may still continue to demonstrate anaemic growth and therefore remain a side-show. However this could be the year when the Euro establishes its ascendancy over the US dollar. On the business front, a key phenomenon that is gaining significance and momentum is offshore outsourcing to Asia of economic activities both in manufacturing and services. This is likely to become a major trend with significant ramifications on Western economies.

The US economy did better than expected in 2003, annual growth is likely to reach a tad above 3%, a welcome recovery from the 2.2 % annual GDP growth achieved at the end of 2002. This remarkable achievement, as we know, was a result of a sustained policy stimulus, the latest being the tax break that resulted in a surge of retail sales in the third quarter. The tax incentives however will continue to provide benefits up to first half of 2004. The Federal Reserve also remained accommodative in its policy by fixing and keeping the Fed Funds rate at 1%. In the New Year, both fiscal and monetary policies are likely to maintain the status quo as the economy will continue to need the stimulus. Self-generating sustainability of growth is still not a certainty in the US, however there are a few encouraging signs in both employment growth and business investment that bodes well for the future. Expect the Federal Reserve and the Treasury to stay policy-neutral for the first half of 2004. But interest rates are likely to move up in the second half when employment growth will have taken hold and inflationary pressure is beginning to show. This should be a gradual rise partly because economic imperatives may not demand it, but more so because 2004 is an election year and it cannot be good politics to be seen raising interest in the middle of a re-election campaign. If the economic trend continues in its current form, expect to see US growth ending 2004 around the 4% mark.

The twin deficit, fiscal and the current account of the US economy are presently the major fault lines in its economic landscape. Come what may, these have to be re-adjusted in due course. We are already witnessing this adjustment happening on the external deficit, through the fall in the value of the US dollar. It has fallen more than 30% from its peak against the Euro. Currently at US $1.22 against the Euro, it looks to be fair value, but as currency market tends to overshoot, one could see the Euro strengthen to $1.30 and eventually falling back to the current level. The fiscal deficit on the other hand is likely to be tackled only after the election. Once President Bush is re-elected, the chances of which get better as the economy strengthens, the US Treasury is likely to pay some attention to this burgeoning debt rising to unmanageable proportions.

Whilst one is unable to ignore the US economy, China on the other hand, is also likely to take a fair share of our attention in the New Year. It is no longer a sleeping dragon, but one that is fully awake and ready to stamp its mark on global economics.

It had yet another year of sizzling GDP growth of around 8%. Its foreign exchange reserves of US$380 billion are the second highest in the world, trailing only Japan, and both together are acting as principal financiers to the US Government by funding its massive fiscal deficit. Its economic importance continues to attract large FDI inflows and it has become unthinkable for any global company not to have a China strategy -- either to shift its manufacturing base to the country, or to plan to sell its product in the domestic market or a combination of both. The China story is huge and growing every day, one can only ignore it at one's own peril.

China's domestic policy is still relatively opaque and difficult to predict. It has pursued an easier monetary policy, which has led to a consumer and investment boom, creating over capacity in manufacturing. Both have long term repercussions and need to be curbed. We are likely to see policy initiatives in this area in the New Year. Its other major problem is its large non-performing loans to state-owned enterprises by the state-owned banks. The loans need to be re-structured or the banks face bankruptcy that will inevitably lead to dire consequence for the economy. Although these are major cracks, it is unlikely any of these will be cause for a near term blow-out.

Externally China is viewed with mixed blessing. Asian economies now love China, because it has become a major importer of their goods. This is a far cry from the earlier days, when China was viewed suspiciously for stealing the rest of Asia's manufacturing bases by offering multinationals a cheaper alternative within China. Imports this year have seen a blistering growth of 40% and the main beneficiaries have been the Asian economies. This is quite a turnaround, and for some Asian economies like Korea, Japan, Singapore, Malaysia and Thailand, China features within their top three largest trading partners, even overtaking the US. This was unthinkable just a year back. At last the Asian economies are not solely dependent on the vagaries of US growth. This is a significant recent trend and likely to gain in prominence and gather roots in the New Year.

Whilst China is the new darling of Asia, it has understandably failed to command similar affection from the US. Instead, the lopsided trade imbalance with the US has angered the current administration. The US has made direct threats by recently imposing trade embargoes on some garment items and television sets. This may be the beginning of a bigger protectionist policy that may unfold in the New Year. The renminbi (RMB) is the other target. The US wants the Chinese currency to be de-pegged from the US dollar and re-valued upwards. So far China has been able to maintain its competitiveness by remaining pegged to the dollar, allowing its value to fluctuate along with the dollar. Hence, when the dollar falls in value, Chinese goods don't get expensive for Americans, but maintain the same value because the exchange rate is fixed at RMB 8.28 for the dollar. The US has a point, with $380 billion in reserves, the RMB is clearly undervalued. In the New Year we are likely to see some policy shift on the Chinese currency. It is unlikely that we will see a free float, but instead a wider band within which the RMB will be allowed to fluctuate. Inevitably this will lead to a higher valuation of the currency. Notwithstanding, China's growth in 2004 is likely to remain on course and gain deeper traction as it continues to serve as the cheapest workshop for the world.

On the business front, with China offering a cheaper manufacturing base and India similarly a cheaper service base, the industrial landscape of a globalised world has been gradually and relentlessly shifting. The current year saw a spurt in offshore outsourcing by the US and European companies, particularly in the service sector where India has benefited most. Global companies are out to get their costs down and development in technology and communication has provided them with the opportunity of establishing their non-essential functions thousands of miles away in Asia.This has led to some political backlash in home countries. The Western economies are seriously concerned about the potential job loss in their economies. Some estimate it to be in the region of 5 million jobs in the next five years for the US alone. Clearly these numbers are more scare-mongering than real, but the reality of cost and increasing quality advantage of Asia cannot be ignored in a competitive global environment. Irrespective of the political backlash, global companies will find it impossible to ignore this comparative advantage especially when the alternative is to face extinction. We will see this shift towards offshore outsourcing taking a firmer hold in the New Year.

Global growth is less precariously balanced than in 2002. 2003 has shown better resilience than expected and has accordingly raised hopes for the New Year. Despite the inevitable fault lines, the global economy in 2004 is expected to pull through better. As for Asia, the US will still continue to be the main engine for growth with China taking an ever-bigger share of that responsibility. At last, an Asian powerhouse to Asia's rescue!

Ghalib Chaudhuri, a former investment banker, is managing partner of Octavian Associates, an independent consulting practice based in Singapore.