Mumbai: The economic development in Asia Pacific will continue to benefit from the three significant sub regional economies in 2007 - China, India, and Japan, says rating agency Standard & Poor's, in its annual outlook for the Asia-Pacific Region in 2007.

China, in particular, continues to be a key driver of regional growth, with the economic slowdown in the US expected to dampen the Asian giant's growth momentum only
marginally - similar to the outlook it holds on India.

The report combines S&P's predictions for equity markets, credit quality and economic performance across the region next year, and includes the latest forecasts from S& P's ratings services and equity research divisions.

It says that Chinese real GDP growth in 2006 is likely to reach 10.5 per cent, after hitting a high of 11.3 per cent in the second quarter. GDP growth in 2007 should hit close to 10 per cent, due to factors including continuing macroeconomic stabilisation measures, tightening fiscal stance, and an over-performed stock market in 2006.

The rating agency expects India's real GDP growth in 2006 likely to reach 8.5 per cent, with a mild slowdown to 7.5-8.0 per cent due to factors including continuing macroeconomic stabilisation measures, tightening fiscal stance, and a likely reduction in stock market returns compared with 2006.

Outlook on China:
Stability in 2007-08 more crucial than ever
Commenting on its outlook for China, Ping Chew, managing director, corporate and government ratings, Asia, says, "The theme of stability in 2007-2008 will be more crucial than ever in guiding policy making. The new set of party leaders will be installed in key government positions during the March 2008 National People's Congress. This will come just before the 2008 Summer Olympics in Beijing. Over this period, conservativeness and gradualism will be even more apparent in implementing key policy changes," he added.

Overall credit metrics sound
Overall credit metrics of the Chinese corporate sector is likely to remain sound, but the divergence in corporate sector credit quality and the higher proportion of sub-investment grade ratings is likely to bring a higher level of volatility to the rated corporate credit portfolio.

"Recently introduced austerity measures to cool down real estate prices may rapidly weaken credit profile of small developers with limited financial flexibility. And high raw material cost and increased price competition due to overcapacity will put more pressure on profit margin for downstream companies in China, " said Ryan Tsang, director and team leader of S&P's corporate, infrastructure and financial institutions ratings, Greater China.

Reforms have benefited banking sector
The outlook on China's banking industry is positive, according to the report. Reform efforts by the rated banks are producing some tangible benefits. Lending is likely to grow in a more controlled manner in 2007, as government is expected to continue to manage the economy to avoid overheat and over capacity in certain industry.

"Having said that, the sector's risk management capability is little tested and remains a key rating factor. Slow down in economic growth could turn the sector's large portfolio of special mention loans into NPLs," said Tsang.

Standard & Poor's expects that the potential growth of the China insurance will remain strong due to its low penetration and the burgeoning economy.

"The increasing focus on improving operational fundamentals, strong potential growth, and regulatory commitment to policyholder interests are likely to offset challenges, such as tough competition, lack of personnel talent, weak capitalisation as a result of ongoing growth, and the industry's need to improve reserving and strengthen risk management," said Connie Wong, director and team leader, insurance ratings, Asia.

Positive on stock markets; cautious on exuberance
On the equity side, the ratings agency remains positive on China although it is "concerned that the stock market rises of over 80 per cent for the A-shares and 50 per cent for the H-shares in 2006 are too exuberant," according to the report.

"Reversion to mean would dictate a normalised performance in 2007," said Lorraine Tan, vice president, S&P's equity research. "We note, however, that for the A-shares, which remain largely a domestic-only equity market, 2006 represents the first year of gains following five years of consolidation. As such, share ownership level remains historically low and valuations are not demanding."

"Our interest in the A-shares, however, is mainly due to their significance to the performance of the H-shares. A rising A-share market is likely to pull H-share prices higher although the converse is not necessarily true given the lower PERs of the H-shares. Our preferred entry to the China market remains through the H-shares," added Tan.

Outlook on India:
Fiscal discipline necessary for any possible sovereign upgrade
Though India's growth would be crucial to the growth of the Asia Pacific region, S&P warns that fiscal discipline would be necessary for any possible sovereign upgrade

It says that India real GDP growth in 2006 is likely to reach 8.5 per cent, while GDP growth in 2007 would witness a mild slowdown at 7.5-8.0 per cent, due to factors including continuing macroeconomic stabilisation measures, tightening fiscal stance, and a likely reduction in stock market returns compared with 2006.

The outlook on India's sovereign credit rating was revised to positive from stable in April 2006, highlighting that if current credit improvements continue, especially on the fiscal front, India could achieve investment grade ratings.

"The country's strong growth prospects remain key to credit strength, while fiscal inflexibility its key credit weakness" said Ping Chew, who heads Asian corporate and government ratings at S&P. "Overall, while the growth trajectory of the economy is expected to continue, India's public finance is particularly vulnerable to any secular decline in growth rates and increase in interest rates.

"Concerns over a strong pick-up in budget expenditure, a result of the front-loading of planned expenditure in the first few months of fiscal 2006-07, have abated somewhat, although this will remain a key focus," he added, cautioning, "Reform efforts also remain at risk from a policy environment that is encumbered by an entrenched bureaucracy, coalition politics, and a fragmented administration".

Credit quality
Overall credit quality of the Indian corporate sector is likely to remain sound in 2007.

"Indian corporates may face pressure from higher debt for funding capacity expansions, potentially weakening operating margins, and from rising interest rates. But improvements in their financial profiles from strong sales growth and cash flow in the past two to three years will mitigate these adverse trends and lend stability to their credit profiles," said Anshukant Taneja, director and team leader of S&P's corporate ratings, Asia ex-Greater China.

Positive on banking sector
The outlook on India's banking industry is positive, according to the report. Consumer credit is the prime driver of credit expansion - growing in excess of 40 per cent each year - and now constitutes more than a quarter of the entire system's credit portfolio. Over 50 per cent of outstanding consumer credit is from inherently less-risky housing loans.

Ritesh Maheshwari, director and team leader, financial institutions ratings, Asia ex-Greater China, said, "Standard & Poor's has a favourable view of banks' increased lending to the under-penetrated consumer sector because credit losses are likely to be lower than in the corporate sector. Moreover, the financial profile of banks has been improving consistently, as evident in the decline of absolute NPA (non-performing assets) and resulting adequate portfolio quality."

Maheshwari added, "The expected strong economic growth will continue to provide opportunities to banks without compromising on pricing or quality. Competition will, however, put pressure on deposit rates, as credit demand will still be enough. Standard & Poor's expects effects of seasoning of loans acquired over the last two years to be visible in 2007 and absolute NPAs to rise. Indian banks will continue to need capital infusions to support growth and implement the new capital adequacy framework. The outlook on all rated banks is positive".

Insurance sector stable
The outlook for India's insurance industry is stable, supported by strong growth momentum.

"While the under-writing performance of the non-life industry will remain weak because the motor insurance business continues to be poor, it will be partially offset by the growth of the health insurance business. Despite competition that will push premium rates of profitable lines downward following the industry's reaction to de-tariffing, the unprofitable motor insurance business may see an upward adjustment of premium rates because this business class is substantially under-priced", said Connie Wong, director and team leader, insurance ratings, Asia.

Booming stock markets
On the equity side, 2006 will mark the fourth consecutive year of gains for the market, with India enjoying robust growth and a prolonged bull run.

"The macro-economic view on India remains favourable for the stock market in 2007," said Lorraine Tan, VP, equity research. "With relatively strong GDP growth, stable interest rates and inflation in check, conditions augur well for stable profit margins and a market EPS growth of about 17 per cent."

"However, equity market valuations have become extended and rising costs - despite the short term lowering of energy prices - could eat into services companies' profitability over the medium to long term. If global investors reduce their holdings in Indian equities, the Indian rupee could come under pressure and exacerbate selling in the stock market. Upside potential would come from a continued re-rating of the market backed by strengthened economic fundamentals, a continued trend of increasing investment in manufacturing and infrastructure; and rising momentum for technology share prices," continued Tan.