World Economy : China to lead the way
Author:
John Beggs
The global economy performed very strongly last year with real GDP up by close to 5%, the strongest rate in almost three decades. The outlook for 2005 and beyond remains positive despite the risks posed by geopolitical factors and higher oil prices.
The outlook is also clouded by uncertainty as to how global imbalances, such as the US current account and fiscal deficits will be managed. The latter have caused problems for the US dollar since 2002 and the future direction of the US currency remains a cause for concern
Asia led the way last year in boosting global economic growth, followed by the US. The eurozone lagged behind last year, despite benefiting from a strong export performance to Asia. Asian real GDP grew by 6.5% in 2004. Within this zone, which accounts for about 30% of global GDP, China grew by 9.5%, India expanded by over 6%, while the rest excluding Japan, which the IMF describes as 'developing Asia', grew by about 5%. The Japanese economy weakened in the second half of 2004 after a promising first half, leaving growth for 2004 as a whole at about 2.6%.
Looking to 2005, prospects for Asia as a whole are favourable. However, Japan is expected to record weaker growth of about 1%. On the other hand, the short-term outlook for China is for continued expansion in real GDP of the order of 8-9%. Outside of Japan and China, the rest of Asia should see growth of around 6%. With slower projected growth in the US, and the euro area continuing with its lacklustre performance, sustaining buoyant global conditions will fall to Asia, and particularly China, in 2005.
The Chinese economy is one of the star performers of the global economy. The rise in Chinese real GDP last year of over 9% was not a one-off event. Over the past 20 years, the Chinese economy has expanded at an annual average rate of almost 8%. Today, according to the IMF, the Chinese economy represents 12% of the global economy measured in purchasing power parity terms.
Growth in the Chinese economy should remain strong over the medium term, perhaps of the order of 8-9%.
India should also experience robust expansion of 5-6%. Japan faces a less certain future but medium term growth of 1.5-2% would represent a satisfactory outcome. Overall, Asian economic growth will continue to expand at a healthy rate which should contribute to steady development of the global economy and of international trade.
China's economic performance in recent years has had profound economic consequences for other countries and the debate is heating up as to its potential wider impact in the future. China has become a source of significant importing and exporting opportunities for the major industrial economies, a major recipient of foreign direct investment, a driver of world oil and non-oil commodity prices at a time of insecurity about global energy supplies, a source of growth for the rest of Asia and a key player in the international financial markets, particularly in relation to the outlook for the US dollar.
In common with many other western economies, Ireland has a merchandise trade deficit with China. This deficit, which stood at €1,630 million in 2003, rose to about €2,200 million in 2004. Merchandise imports from China last year rose by about 29% while exports to China rose by around 14%.
In terms of the value of merchandise imports to Ireland, China now ranks as Ireland's fourth most important trading partner, accounting for over 5.5% of total merchandise imports.
On the export side, however, merchandise exports to China account for less than 1% of total merchandise exports. This clearly implies that there is plenty of room for improvement, which many Irish companies are actively seeking to rectify.
Looking at the wider picture of Irish trade with Asia, Irish merchandise imports from that area accounted for about 19% of total merchandise imports in 2004. On the export side, Irish trade with Asia was equivalent to about 8% of total merchandise exports last year. Ireland had a trade deficit of €2,900 million with Asia in 2004, three quarters of which was accounted for by trade with China.
China accounted for over 30% of total Irish merchandise imports from Asia in 2004. Total imports from Asia rose by about 10% last year. Excluding China, however, the rise in imports was just about 3.5%. As regards exports, Irish merchandise exports to Asia increased by 11%. This figure was broadly unchanged when trade with China was excluded.
As has been observed in many other western economies, growing trade relations with China, particularly on the import side, may be expanding at the expense of imports from other Asian economies. With China maintaining a fixed exchange rate vis-à-vis the US dollar, the rise in the value of the euro versus the US currency, and the associated deterioration in cost competitiveness, has also been felt against the Chinese yuan. This also contributed to the rise in Irish imports from China. Irish trade with Japan in 2004 on the other hand saw Irish imports down by 5% while exports to Japan rose by about 12.5%.
China represents a growing competitive challenge to its other Asian neighbours in terms of their ability to export to non-Asian markets. However, it is also true that China has provided the Asian economy with opportunities for more self sustaining expansion at a time of economic weakness in Europe and recovery in the US.
Of course, while not all of the growing importance of Chinese international trade can be laid at the door of the undervalued yuan, the latter undoubtedly had some impact. Over much of last year, the European Central Bank maintained that while the rise in the value of the euro posed a risk to eurozone exports, the growth in world trade, which was over 8% last year, was a far more important factor in determining the overall performance of eurozone exports.
Global Outlook
The outlook for the global economy remains at risk from the scale of the US fiscal and current account deficits. The US has large trade deficits with most regions of the global economy. In most cases, these deficits have developed against a background of flexible exchange rate regimes. However, the Chinese yuan's fixed rate relationship with the US dollar and its growing external account surplus with the US has been centre stage at recent G7 meetings. China's exchange rate policy, therefore, has emerged as a key factor in discussions about maintaining stability in the global financial system.
Having appreciated by almost 40% on a broad trade weighted basis in the 1995-2002 period, the US dollar has been in a downward phase since then. However, to date, the fall in the dollar's broad index has been no more than 15%. This is insufficient to bring about any meaningful fall in the US current account deficit of around 6% of GDP. During this period of downward adjustment, the dollar has fallen by 45% against the euro
The dollar's adjustment against the Asian bloc, however, has been more limited. Thus the call, first heard at the G7 meeting in Dubai in September 2003, for more flexibility in exchange rate movements. This was a reference not only to China but also to the situation where other Asian central banks are resisting pressure to allow their currencies to appreciate versus the dollar.
Financial markets believe that if the Chinese authorities were to agree to more flexibility, the yuan would appreciate versus the dollar. This in turn would encourage the Japanese to allow the yen to gain versus the dollar. However, with the Japanese economy apparently back in the doldrums, the Japanese authorities are unlikely to favour any renewed strengthening of the yen versus the dollar .All of this is by the way as the Chinese authorities continue to resist calls to alter the current exchange rate regime. The Chinese believe that there is a need for more capital account liberalisation before moving towards greater exchange rate flexibility. Arguments have been advanced by the IMF and others that a more flexible exchange rate would enable China to exercise a more independent monetary policy, providing the authorities with scope to deal with internal and external shocks.
The rise in Chinese inflation over the past year which raised fears of overheating, could have been tackled with a stronger exchange rate. However, inflation has since eased, at least in the short term, taking pressure off the authorities to adjust the currency. In the short to medium term, therefore, it would appear that the current exchange rate policy stance will be maintained. If further pressure is to come on the US dollar, therefore, it seems that the European and commodity related currencies will have to bear the brunt of this adjustment.
In summary, the outlook for the global economy remains positive. China is expected to lead the way, promoting the development of intra-Asian expansion and trading relations with non-Asian economies. Among the latter, the US should also perform well, though the eurozone will continue to underperform. Clearly, there are a number of geopolitical risks, higher oil prices and currency market uncertainty to contend with but experience over the past few years has shown that the major economies are resilient and have the capacity to adapt to new challenges.
John Beggs is Chief Economist with AIB Global Treasury.