GDP UPDATE 

January 2007

McIlvaine Company

INDUSTRY ANALYSIS
    1. AMERICAS
        U.S.

If 2007 were a month, it would be a March — only in reverse. Experts generally expect the economy to behave more like a lamb during this year's first half but to pick up steam and go out like a lion as 2008 draws near. A steep housing slump and manufacturing's ongoing woes will continue to undermine growth early this year, forecasters agree. But they see job and income gains, while less than last year, and interest rates cuts by the Federal Reserve to put enough money into the pockets of consumers to bolster growth as the economy makes its turn into the second half.

"The recession in the housing market does not seem to have had much of an impact on the consumer," said Nariman Behravesh, chief economist at Global Insight, a Waltham, Mass., forecasting firm. "The bad news on housing has been offset by good news on wages, jobs and the stock market."

Bruce Kasman, head of economic research at J.P. Morgan Chase & Co. in New York, agreed. "As long as you don't think the labor market is going to collapse or financial conditions are going to change, then you're starting to have the conditions for better growth down the road," he said.

On average, 60 economists who participated in The Wall Street Journal's semiannual economic forecasting survey predict that inflation-adjusted gross domestic product, a broad measure of economic activity, will grow at an annualized rate of 2.3% in the first half of 2007 and 2.8% in the second half. That's up from a sluggish 2% in the third quarter of 2006, but still far below the robust annual growth rates of 3.2% for 2005 and 4.1% for early 2006.

The overall economy, as measured by the gross domestic product, expanded in 2006 by 3.3%, many economists believe, just slightly above the 3.2% GDP growth of 2005. That increase reflected a surge at the start of the year as the economy rebounded from the impact of the 2005 Gulf Coast hurricanes and much slower growth starting in the spring, as consumers were hit by rising interest rates, soaring energy prices and the slumping housing market.

For 2007, Global Insight is forecasting a GDP growth rate of just 2.3%, a full percentage point lower than in 2006. That would be the slowest pace since the economy grew by just 1.6% in 2002, a year when the country was struggling to recover from the 2001 recession. Almost all the growth will come in the nation's booming service sector, where the rapid expansion of technology companies such as Google Inc. and the huge bonuses lavished on New York investment bankers are signs of the sector's strength.

Across the country, restaurants, hospitals, software makers and consulting firms are growing and hiring. All told, service businesses, which make up about 80% of the nation's economy, added 1.1 million jobs from May through November.

"We've been extremely busy," says Anthony Kolton, president and chief executive officer of Logical Information Machines, a Chicago company that provides research software to hedge funds, trading firms and investment banks. "There's a lot of money out there, and people have to put it to work."

The upbeat attitude in services contrasts sharply with the recent pain in the housing and manufacturing sectors. Builders have been slashing prices and production as they attempt to get rid of a large backlog of unsold homes. Despite a rise in November, new-home construction was down 30% from its January peak. The drop-off is showing up on the jobless rolls, with economists at Goldman Sachs estimating that housing-related industries -- construction, furniture manufacturing and sales, real estate agents, mortgage brokers -- will see more than 1 million jobs evaporate over the next two years because of the housing slowdown after five boom years for sales.

The auto industry also is expected to suffer as U.S. car companies complete announced plans to trim their work forces in the face of stiff foreign competition. Troubles in auto-related industries have contributed to recession-like conditions in many parts of the industrial Midwest while many southern states are confronting job losses as a result of a surge of Chinese imports of textiles, clothing, paper and furniture. For most of the country, however, the economic slowdown won't have much of an impact as long as there are no unexpected shocks that could send growth lower than forecast.

The strength in services will help to keep the job market relatively healthy, with non-farm businesses adding about 100,000 jobs a month this year, according to the Wall Street Journal consensus forecast. That should be strong enough to slowly lift wages, but not to keep the unemployment rate from creeping up to 4.9% from 4.5% in November.

The economists surveyed expect year-to-year inflation to decline to 1.7% in May from 2.0%in November. As a result, they expect the Fed to shift its focus from fighting inflation to helping the economy grow, lowering short-term interest rates to 4.75% by the end of 2007 from the current 5.25%.

That's a big change from six months ago, when forecasters saw the Fed's battle with inflation as the greatest challenge facing the economy. "The Fed was hoping to slow the economy down enough to take the wind out of inflation without triggering a recession," said Global Insight's Behravesh. "So far it looks like it has succeeded."

If the Fed succeeds in its soft-landing goal, many economists believe the stage will be set for a solid rebound to a 3%-plus GDP growth rate in 2008 and beyond. That would resemble the pattern of the mid-1990s, the last time the Fed succeeded in bringing about a soft landing for the economy.

"I think 2008 will turn out to be a very good year for the economy," said Mark Zandi, chief economist at Moody's Economy.com. "The Fed will feel more comfortable with stronger growth because inflation will be under control."

    2. ASIA
        CHINA

The Chinese economy is expected to have grown 10.5% in 2006, while its trade surplus is expected to total US$170 billion, the chief economist of the Chinese National Statistics Office, Yao Jingyuan estimated recently. The growth of China's Gross Domestic Product (GDP) is expected to exceed that of 2005, which was 10.2%.

The US$170 billion trade surplus is a new record, after the surplus stood at US$101.9 billion last year. From January to November, China’s trade surplus had risen to US$156.5 billion, a rise of 72% year on year, according to recent figures from China’s customs services.

        INDIA

The Indian economy is on the fulcrum of an ever-increasing growth curve. It grew by an impressive 9.2% during the second quarter (Q2) of 2006-07 (July to September) taking the first half gross domestic product (GDP) growth to 9.1%. In the first quarter (Q1) the growth had been only slightly less robust at 8.9%.

The growth in GDP would have been still higher if agriculture growth had not slumped to 1.7% in Q2. Industry and services both recorded massive improvements during this period at 10.3% and 10.9%. Such high growth has led forecasters to raise GDP projections for the current year. Most analysts had earlier estimated that GDP growth in 2006-07 would be lower than last year's 8.4%. (CII had made a forecast of around 8%). The actual growth has exceeded all expectations.

Infrastructure - rather, the lack of it - remains, however, a major drag on the economy. Even the finance ministry has been crying itself hoarse on the need to reduce revenue expenditure to enable larger public investment in the sector. "Weak infrastructure continues to be the Achilles Heel of the Indian economy. Fiscal space needs to be created by cutting down revenue expenditure, including subsidies, to enhance public investment in specified infrastructure where cost recovery is not possible," the Finance Ministry observed in its Mid-Year Review of the economy.

Inflationary pressures have also marked the first six months of the current financial year. The point-to-point inflation rate, based on the Wholesale Price Index (WPI) reached a peak of 5.5% in mid-June 2006. Yet economists seem bullish on the growth prospects of the economy during the coming months. "Based on the evolving nature of the current economic situation and indicators of a prospective nature, we expect the GDP in the second half of the 2006-07 to grow by 8.2%, with a rebound in the performance of agriculture to 3%, and a marginal slowdown in the growth of industry and services to 9.1% and 9.7% respectively", maintains the latest 'State of the Economy' report of the CII.

SINGAPORE

The growth of Singapore’s economy accelerated in the fourth quarter, providing support to private economists’ views that economic expansion in 2007 could exceed the government’s forecast of 4 to 6%. The government reported that the economy expanded at an annualized rate of 7.6%in the fourth quarter from the previous quarter, its fastest pace in a year and higher than market expectations.

Lee Hsien Loong, Singapore’s prime minister, warned in his new year’s message that the economy would slow in 2007 due to weaker demand in the US. But private economists believe the government is too pessimistic. “Weaker US demand is being offset by China and India and Asia in general,” said Adrian Foster with Dresdner Kleinwort in Singapore.

On a year-to-year basis, however, economic growth slowed to 5.9%in the fourth quarter, with manufacturing expanding by 7.3%, services 6% and construction 2.4%.

The release of the economic data, which is based on preliminary readings for October and November, helped push the benchmark Straits Times Index above 3,000 for the first time and boosted the Singapore dollar to its highest level against the US dollar in nearly a decade.

The government reported that the economy grew 7.7% in 2006, within the range of the last government forecast of 7.5 to 8%, The economy expanded by 6.4% in 2005 and 8.8% in 2004.

Much of the economy’s growth in 2006 came from increased exports of electronics, pharmaceuticals and chemicals. Analysts believe, however, that the economy in 2007 will not match its 2006 performance due to a stronger Singapore currency and higher oil prices affecting global demand for exports.

The proposed raising of Singapore’s sales tax ìn the coming months to 7% from 5% might curb local demand, which has been seen as helping counter reduced exports. However, the government is hoping that a recovery in the construction industry, reflected in higher property prices, might bolster the local economy. Singapore said that home prices rose by 10%in 2006, including 3.7%in the fourth quarter.

Singapore has also been seeking to diversify its economy to reduce its dependence on exports. It recently issued licenses for the building of the city-state’s first two casino resorts, which are expected to nearly double the annual tourist visits to 17m by 2015. Singapore drew a record 9.5m visitors in 2006, which helped create the largest ever annual rise in the number of new jobs.

But the government admitted that average wage growth was not keeping up with economic expansion. In the past five years, per capita gross domestic product grew by 4.3% annually while average wages grew by 2.1% The government has suggested that it may require companies to increase contributions to the national pension scheme to support workers’ welfare. Corporate pension contributions were cut several years ago to increase Singapore’s competitiveness in attracting foreign direct investments.

SOUTH KOREA

The government said that it expected economic growth to cool in 2007 from an estimated 5% last year as a global slowdown reduces demand for the country's exports and consumer spending remains weak. The third-largest Asian economy, after Japan and China, South Korea is projected to expand 4.5% this year as export growth slows to 10% from an estimated 13%, the Ministry of Finance and Economy said. Growth in private spending is expected to slow to 3.9% from 4.2%.

"External and internal economic conditions aren't better than 2006," the ministry said. "Global economic growth is expected to slow somewhat, and the deterioration of external factors like oil prices and the currency will start to affect the economy."

The ministry forecasts are in line with those of the Bank of Korea, which said last month that the $788 billion economy would slow this year to 4.4% as demand cools in the nation's biggest export markets and consumer spending slackens at home. The Organization for Economic Cooperation and Development predicted the same growth as the central bank. A slowing world economy means that demand for South Korean cars, chips and other goods could fall. Exports, which account for about two-fifths of the economy, will probably rise at the slowest rate in five years in 2007, the Commerce Ministry said.

A stronger currency also threatens to cool the South Korean economy. The rising won makes Korean goods sold overseas more expensive and erodes profit repatriated by exporters like Samsung Electronics and Hyundai Motor. The won rose 8.6% against the dollar last year, and government officials are concerned about a further rise.

"We will put together aggressive measures and manage so that the currency issue doesn't burden the economy," President Roh Moo Hyun said Wednesday. "We need to set a longer-term management strategy so that the currency situation doesn't deteriorate."

Separately, confidence among South Korean consumers fell for a second time in three months in December, indicating consumer spending could decline and threaten to slow economic growth. The sentiment index dropped to 93.7 last month from 95.2 in November, the National Statistical Office said, citing unadjusted figures. A reading below 100 indicates more people are pessimistic than optimistic. The drop in confidence may prompt consumers to spend less, compounding an economic slowdown driven by reduced global demand for South Korean exports.

SRI LANKA

Sri Lanka's economy grew 7.5% in the third quarter ended Sept. 30, the central bank said, while lowering full-year growth forecast to 7.0%. Growth during the third quarter of this year, was faster than the 6.9% expansion in the same quarter of 2005.

"This expansion was broad-based, with higher growth in telecommunication, cargo handling, financial services, trade and from the higher usage of hydropower due to extreme weather," the central bank said. Growth in the third quarter was led by the services sector, which grew at a high of 8.5%, while the agriculture and industry sectors grew by 4.5% and 7.4%, respectively, over the same period last year.

"The services sector continued to dominate, contributing 63% to the growth, while the industry and agriculture sectors contributed 27% and 10%, respectively," the bank said in a statement.

The third quarter figure helped lift nine months GDP to 7.8% as against 5.8% growth in the corresponding period of 2005. The bank said the fourth quarter performance will be lower than the growth in the first three quarters, due to "lower than expected performance in the tea, external trade and tourism sub sectors."

The Central Bank also lowered the island's 2006 full year economic growth to 7.0% from 7.4% announced earlier. The forecast for 2006 is in line with the International Monetary Fund's expectations of 7.0%. However, the Census & Statistics Dept said earlier this month that the island was set to record a 7.4% economic growth this year, over 6.0% a year earlier, which is the best in nearly three decades. The previous best growth performance was in 1978, when the economy expanded by 8.2% after the government ditched its socialist policies and embraced free-market reforms.

However, the island's spiraling ethnic conflict could hit growth in 2007. In its annual review known as the Article IV consultations released recently, the IMF said Sri Lanka's quest for 7-8% growth hinges on improved business climate, productivity improvements, rationalizing trade regimes and financial sector reforms. "However Sri Lanka's near- and medium-term economic prospects depend critically on progress on the peace front and on implementing essential reforms," the global financial watchdog warned referring to the long running ethnic conflict that has claimed over 60,000 lives since 1972.

Military confrontations between the government forces and the Tamil Tiger rebels have intensified recently, claiming over 3,500 lives since last December, and progress to settle the conflict through multi-party negotiations remains limited. "With only minor interruptions in most parts of the country, growth is projected at 7%. Financial markets have remained calm, though investor confidence has been somewhat weakened by increased uncertainties," the Fund said.

    3. EUROPE / AFRICA / MIDDLE EAST

COMMONWEALTH of INDEPENDENT STATES

The Statistics Committee of the Commonwealth of Independent States (CIS) has predicted that gross domestic product (GDP) of Uzbekistan will fall from 7% in 2006 to 6% in 2007. According to Uzbek President Islam Karimov, the Uzbek economy grew by 7.2% in 2006. The country's state budget for 2007 forecasts 7.7% growth of GDP in 2007.

IMF web site also said that the Uzbek real GDP grew by 7.2% in 2006 and said that the Uzbek economy will grow by 7% in 2007.

The CIS body said the GDP of Belarus will increase by 10% in 2007 and Moldavia will record 4-5% GDP growth this year.

The GDP is projected to increase from 6.3% in 2006 to 7% in 2007 in Ukraine and from 2.8% to 6% in Kyrgyzstan.

The committee noted that GDP was expected to fall by 4% to 30% in Azerbaijan, from 12% to between 7%-9.5% in Armenia, by 2% to 5% in Georgia and by 0.6% to 6% in Russia.

Kazakh economy will fall from 10% in 2006 to 7-7.3% in 2007, the committee said.

It has also predicted that the member countries' GDP will rise by 7% on average in 2007.

FRANCE

French Budget Minister Jean-Francois Cope, in an interview with the daily Le Figaro, reaffirmed the government's 2006 GDP growth forecast of 2.0-2.5%, without elaborating on this point.

GERMANY

German GDP growth will slow to 1.7% this year from an anticipated growth rate of 2.3% in 2006, according to forecasts published by the Berlin-based economic think-tank Deutsches Institut fuer Wirtschaftsforschung (DIW).

In 2008, GDP growth is expected to accelerate to 2.5%, the institute said in a statement.

The outlook for 2007 and 2008 is "favorable" despite the Jan 1 increase in value-added tax, a restrictive monetary policy, the appreciation of the euro, a slight slowdown in global economic growth and expected higher wage deals, it noted.

The DIW said its forecasts are based on the assumption that the European Central Bank will hike its key interest rate to 4% this year. The ECB last raised interest rates on Dec 7, hiking the minimum bid rate on its main refinancing operations to 3.50% from 3.25%.

ISRAEL

Despite the war in the North, Israeli gross domestic product grew 5% this year, according to preliminary figures released by the Central Bureau of Statistics (CBS), beating economists' expectations as exports of goods and services and investment in fixed assets surprised on the upside.

"The Israeli economy this year grew faster than our estimates following the war in the Lebanon which stood at 4.5%, but somewhat slower than our original forecast for the year before the war which stood at 5.4%," said Shlomo Maoz, chief economist at Excellence Nessuah. "The higher than expected growth rate was driven by strong growth in investment of fixed assets and industrial exports, which doubled compared with last year, and an end of year balance of payments surplus of $3.9 billion compared with $2.9b. in 2005."

In the aftermath of the war, economic growth slowed to an annualized 2.9% in the second half of the year, compared with 5.9% in the first half of 2006, according to the preliminary national accounts figures published by the CBS. The agency improved its last growth forecast in October of 4.5% to 5%, while the Bank of Israel last month raised its 2006 growth estimate to 4.8% from 4.6% and its 2007 GDP growth forecast to 4.6% from 4% as the repercussions of the Lebanon war were found to have weighed less on the economy than previously estimated.

Business sector product rose by more than 6.3% this year compared with 6.7% in 2005, led by strong industrial product growth, which rose by 8.2%, the CBS said. Exports of goods and services grew 5.1%, similar to 2005, boosted mainly by the growth rate of manufacturing exports (excluding diamonds) which nearly doubled from 6.4% in 2005 to 12.6% this year. Meanwhile, tourism services exports increased by only 1.2% in the aftermath of the war compared with a growth rate of 28.4% in 2005.

In addition, the growth rate of investment in fixed assets more than doubled to 6.1% from 2.9% last year.

Furthermore, the government deficit was cut in half from 2.4% of GDP in 2005 to 1.2% this year despite the mounting costs of the war. The government deficit totaled NIS 7.2b. in 2006, a reduction of NIS 6.7b. from 2005, as government revenues increased by 8.7% compared with 6.4% in the previous year.

Another major factor that contributed to economic growth this year were the figures for the current account surplus, which nearly doubled from NIS 3.8b. to NIS 7.3b. in 2006, making up 5.2% of GDP compared with 2.9% in the previous year.

OMAN

Oman's gross domestic product (GDP) of the oil and non-oil sectors in current prices surged up to 6654.1 million Omani riyals in the first half of this year from 5463.8 million Omani riyals in the same period of 2005, up 21.8%, official statistics showed. Oman's GDP of oil extraction, relevant secondary services and natural gas extraction surged up by 27% to 3147 million riyals in late June 2006 from 2477.7 million riyals in the same period of 2005, they noted.

The hike in the GDP is also owing to a rise in non-oil activities by 16.7%, having totaled roughly 3390.4 million riyals in June 2006 compared to 2904.3 million riyals in June 2005, the statistics added.

Industrial activities also rose by 36.3% to total 833.5 million riyals against 611.6 million riyals. It is also ascribed to the high GDP in the service sector by 12%, having totaled roughly 2472.6 million riyals against 2206.7 million riyals in the first half of 2005.

However, the GDP of the agricultural and piscine sector fell 2% to 84.4 million riyals from 86.1 million in the same period of 2005, the statistics indicated.

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