Five Megatrends for Asia in 2007

After a year of expansion across the continent, here are five trends to keep an eye on, from high-speed growth in China to inflation in India

No doubt about it, Asia's economic dynamism was on full display in 2006. China and India dazzled the world with high-speed growth rates. The mainland's biggest bank, Industrial & Commercial Bank of China, raised a record-busting $22 billion in the world's largest-ever initial public offering.

Japan, meanwhile, marked the anniversary of its longest postwar economic expansion. And the region saw some frenetic deal making thanks to the growing ranks of cash-rich companies from Mumbai to Singapore and the wave of global private equity funding now streaming into Asia.

Heading into 2007, the broad outlook is quite good, but the region isn't without its challenges and there will surely be surprise developments. While crystal-ball gazing is always a dangerous sport, here are five trends already in motion that seem likely to shape the major business stories in Asia next year.

China: Reining in Social Unrest

If there is a scenario that keeps upper-echelon Communist Party officialdom on edge, it has to be the prospect of a massive wave of social unrest tearing the county apart. China's dazzling growth statistics—the mainland's 10%-plus economic growth, a $1 trillion stockpile of foreign currency reserves, the $1.5 trillion in global two-way trade the country rakes in—rightly get plenty of attention.

China is a fantastic growth story—but it's also a developing economy with big disparities in wealth between the educated, white-collar residents of prospering coastal cities and the farmers and migrant workers who can barely make ends meet. A December study by the China Academy for Social Sciences showed that the poorest 20% of Chinese get just 4.7% of total income, while the wealthiest 20% take home half. That kind of income inequality—previously unheard of on the mainland—is similar to the levels seen in some of Latin America's least equitable societies. That is likely to foster social envy and, when combined with widespread government corruption and world-class smog and environmental degradation, creates a combustible mix.

Beijing party cadres are definitely worried. A recent study by the Sociology Dept. of the Central Committee of the Chinese Communist Party School published Dec. 18 in the state-controlled Beijing Daily revealed that nearly 37% of government officials viewed social unrest as the key problem facing the country. The wealth gap was No. 2.

Though a bloody clash on the scale of the Tiananmen Square incident is unlikely, next year could see some nasty confrontations that probably will get reported, given the influx of foreign journalists coming to China ahead of the 2008 Beijing Olympics. Disgruntled Chinese know that any really rough police tactics have a better shot of being revealed to the rest of the world then—and some may be tempted to take advantage of that fact. Count on more publicized cases of corruption crackdowns by Beijing in the state-controlled press to help assuage public anger.

Meanwhile, the U.S. and other Chinese trading partners can pretty much forget any meaningful moves by President Hu Jintao's government to let its undervalued currency (the yuan) appreciate dramatically or otherwise cool off its labor-intensive export sector in 2007. If there is a meta-theme that will best predict Chinese behavior in the next year or so, keeping a lid on social unrest is the predominant one.

India: Wrestling Down Inflation

In 2007, Reserve Bank of India governor Yaga Venugopal Reddy will have to pull off one of the most delicate balancing acts in central banking. The Reserve Bank of India has already raised interest rates several times over the past year, and on Dec. 8 increased the proportion of deposits that India banks are required to keep in cash. Yet India's $780 billion economy shot up an unexpectedly robust 9.2% in the third quarter over the year-ago period and could be clocking 10% growth in the year ahead. Credit Suisse in Hong Kong even thinks India has a shot of outpacing China in 2007 in terms of economic growth.

The problem: Wholesale and consumer price inflation has shifted into the 5%-plus range, which is above the central bank's comfort zone and Reddy has publicly stated that economic overheating is a now a worry. Indian salaries in service and manufacturing jobs rose about 14% this year, the highest in Asia according to a survey by the human resources firm Hewitt Associates. And it forecasts 2007 salary advances in the 12% to 15% range. That has some economists calling for another interest rate hike of 50 basis points early in 2007 to prevent inflation from really running off the rails.

Trouble is, Prime Minister Manmohan Singh's government is pressing for Chinese-style growth rates of 10% or more to help alleviate India's still considerable poverty problem, particularly in rural areas of the country. New Delhi plans to spend $20 billion-plus on infrastructure projects in the fiscal year that started in April.

When to pull the trigger on the next rate hike will be a very tough call and will test the market credibility of the central bank. The instinct to want to keep the economy in high gear is understandable, but the kind of lost purchasing power that rapidly rising prices can usher in can create political headaches, too.

Japanese Constitution: Time for a Rethink?

Constitutional reform usually elicits yawns. Not so in a Japan that has become far more assertive in its foreign and national security policy. Japanese Prime Minister Shinzo Abe has called for passage of legislation that would set the stage for changing important aspects of the country's constitution, which was basically written by U.S. Occupation authorities in Japan.

Abe thinks its time for Japan to trade in its low-key, postwar foreign policy (and guilt from its military past in Asia) for a bolder, more assertive posture in world affairs. That may mean playing a more direct role in international military clashes and hot spots, something now very difficult thanks to the Japanese constitution's war-renouncing Article 9.

Will Abe succeed? Japanese public opinion has grown more hawkish thanks to the provocations of North Korea on the nuclear weapons development front. Some officials from Abe's ruling Liberal Democratic Party have noted that the current constitution doesn't rule out Japan developing its own nuclear weapons, though the country currently has no intention of doing so.

Japan likely won't go nuclear anytime soon, but it is jointly developing and deploying high-tech anti-missile systems on some of its naval assets. For Abe, getting a national referendum passed and Diet approval likely will be a tough, multiyear effort. However, he seems serious about making this his most important goal as prime minister.

Living With a Descending Dollar

The Thai market crash turned out to be a short-term phenomenon—but the underlying cause behind it is anything but. The big decline of the dollar vs. the Thai baht and Korean won is starting to cause economic pain in some Asian economies. That's why Thai Finance Minister Pridiyathorn Devakula felt it necessary to slap on foreign currency controls to save the country's export-dependent economy.

They were quickly reversed for the most part. Yet both the Thais and the South Koreans are calling for international pressure to keep the dollar stable. After all, the U.S. is by far the region's most critical export market. Still, these countries might also put some pressure on Asia's two biggest economies: Japan and China.

Beijing monetary authorities carefully manage the yuan's trading range against a basket of foreign currencies. Japan, meanwhile, has intervened heavily in the past to prevent the yen from appreciating too rapidly vs. the dollar. All this is putting the big squeeze on middling Asia economies that don't have the monetary clout to keep their currencies stable. These tensions are bound to increase in 2007.

Toyota's No. 1! Who Cares?

Sure, Toyota (TM) will probably overtake General Motors (GM) as the world's biggest automaker by sales—and Asian auto companies such as Nissan (NSANY), Honda (HMC), and Mazda (MZDAF) will continue to make market share grabs in the U.S.

But here's a prediction: Though there will be hand-wringing in the business press and in Washington about U.S. industrial decline, ultimately this story will turn out to be a non-event. Most U.S. car buyers really don't care that much about which company produces their car, just as long as it is the product of quality engineering and design.

Also, most foreign carmakers, and certainly Toyota, have invested huge sums in U.S. plant capacity and provide well-paying manufacturing jobs all across the U.S. So there is little incentive for U.S. lawmakers, especially in states where Asia transplant factories have been located, to make a fuss. Like it or not, what's good for Toyota is now good for the U.S.

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