'A new paradigm'

Provided China's economy continues to grow strongly and oil prices do not rise unduly, we are optimistic that Asia ex-Japan will enter a new paradigm in 2005. The new paradigm will entail robust domestic demand – a green light for Asian policymakers to finally allow significant currency appreciation, which will further rotate the mix of GDP growth toward domestic demand. We are forecasting China's renminbi to appreciate by about 5% against the US$ this year, and most other Asian currencies to appreciate by 10-20%. In this new paradigm, the region's large current account surpluses should narrow sharply, by over US$100bn over the next two years. And in a major break from the past, Asian central banks stand to lag behind the US Fed in raising rates, as monetary conditions tighten significantly via exchange rate appreciation.

McKinsey & Co on China's growing demographic and pension woes:
Falling birthrates and longer life expectancies are combining to raise the average age of the population in North America, Europe, and parts of Asia. Longer life spans will strain retirement systems as withdrawals begin to outweigh contributions.

In the United States, President Bush seeks to overhaul Social Security, in part to address the declining ratio between active workers paying taxes to finance the system, on the one hand, and retirees, on the other.

China too is facing a pension shortfall as a generation-long effort to reduce the birthrate raises the average age of the population and as the traditional family approach to caring for aged parents erodes. Anticipating the need for adjustments, 10 years ago China began to shift from a pension system in which current workers finance the benefits of retirees to one in which current workers contribute to funds that would eventually provide them with income. But contributions haven't kept pace with withdrawals, and the balance is dipping into deficit.

China's policymakers have a number of options, and some would give domestic and foreign securities firms sizable opportunities. One proposal involves turning more state-owned enterprises into publicly traded ones, thus generating additional equity around them. Another is to create a system in which employers and employees would make contributions to designated funds, with payouts in proportion to their performance and to each individual's contribution. These and other proposed reforms depend on the further development of capital markets in China, on the emergence of a value generation culture there, and on better monitoring of companies and enforcement of securities regulations.