What are the recent development in capital market?

Having grown by over 5 percent in 2004, the global economy is projected to continue expanding in 2005. Healthy corporate balance sheets, accommodative macroeconomic policies, and favorable financial market conditions are all helping to sustain the expansion.

Inflation remains reasonably subdued so far - the second-round effects of higher oil prices have not been significant. With monetary tightening underway in most cyclically advanced countries, inflation expectations are generally well-anchored. In addition to further increases in oil prices, however, one risk to this outlook in some countries is a significant rebound in unit labor costs as labor markets tighten, especially if productivity growth were to weaken. Further, strong foreign exchange inflows pose a challenge for monetary policy in some emerging markets - notably in Asia and the Commonwealth of Independent States. Without more exchange rate flexibility, these inflows will ultimately be monetized and result in higher inflation.

The behavior of interest rates is a central issue in the current economic outlook. The current low level of long-term interest rates is contributing to a very favorable global financial environment. Despite the increase in recent weeks, interest rates remain low for this stage of the business cycle, and both corporate and emerging market spreads are near their historical lows. While the low level of long-term rates can be partly explained by a number of factors - including the confidence of financial markets in central banks' commitment to low inflation, excess capacity in labor and product markets, and continued strong demand for U.S. Treasury securities by the official sector, especially in Asia - rates can be expected to rise to more neutral levels, and spreads to increase, as the global economic upswing continues. A major concern is that the rise not be so abrupt as to cause disruptions in financial markets, or impact the overall global economic outlook.

A downward bias remains on short-term risks. On the upside, strong corporate balance sheets and wealth effects from rising equity markets could lead to stronger than expected domestic demand. On the downside, the key risks include further exchange rate volatility, faster than expected rises in interest rates (for example, if triggered by inflationary pressures), and extended weakness in the euro area and Japan. Moreover, oil prices have recently risen above their October peaks and continue to be volatile. With excess capacity very low, the oil market remains highly susceptible to shocks

Divergences in regional growth rates have also widened, and global imbalances worsened, in the past few months. Growth forecasts have been revised upwards for the United States, China, and most other emerging economies. In the euro area and Japan, however, growth projections for 2005 have been marked down significantly, reflecting both faltering exports and weak final domestic demand. The U.S. current account deficit has continued to widen, to over 6 percent of GDP by the end of 2004. And it is expected to remain high in the coming years.

The continuing build-up of the large current account deficit in the United States, with counterpart surpluses and reserve accumulation concentrated mainly in emerging Asia, is a key concern. It is also a main source for many of the risks facing the global financial system, which I shall come to shortly. Solving this global imbalance problem should be an urgent priority. The steps that must be taken by the relevant players are well-known by now, but nevertheless deserve repeating. They are:

ā€¢ Medium-term fiscal consolidation in the United States;

ā€¢ Structural reform in Europe and Japan to increase economic growth, particularly labor market reform; and

ā€¢ Greater exchange rate flexibility in China and emerging Asia.

Prospects for International Financial Markets

Against this background of an expanding world economy, global capital markets are expected to see solid, if slowing, earnings growth. As noted earlier, there is limited inflationary pressure, balance sheets of the corporate, financial and household sectors continue to strengthen in many countries, and the credit quality of emerging market borrowers continues to improve. Combined, these favorable fundamentals support financial market stability. Let me go into more detail.

The overall excellent profitability of the corporate and financial sectors over the past few years has been an important factor in the strengthening of their balance sheets. The ratio of liquid assets to debt has risen and stayed at a relatively high level for some time now. So far, this preference for liquidity reflects the caution of corporate executives in making investments. This has contributed to the slow growth in employment in many countries. By the same token, this cautious attitude has helped to contain the risk of creating investment excesses in the recovery phase that, in the past, have contributed to sharp market corrections.

At the same time as financial institutions have improved their profitability, they have also strengthened their capital bases and risk management systems. In particular, solvency ratios in the insurance sectors of many countries have been improved. These developments have made financial institutions more "weather-proofed" against potential future shocks. All in all, there has been significant improvement in the health of the financial system up to the early part of 2005.