With the powerful and populous economies of India and China leading the charge, Asia is set for another year of impressive growth. The only things that could mar that outlook is a recession in the U.S. and inflation in China.

Strong interregional trade and — as their populations become wealthier and consume more goods and services — strong domestic demand are benefiting Asian countries other than China. (For China’s outlook, see page B17.) With some three billion people residing in Asian countries and participating in its economic emergence, the Asian boom is becoming self-sustaining, even as U.S. growth loses steam.

“Asian countries are the fastest-growing countries in the world,” says Eng Hock Ong, manager of AGF Asian Growth Class Fund, sponsored by Toronto-based AGF Funds Inc. , in Singapore. “We’re looking at strong export growth across the region. Liquidity conditions are buoyant, currencies are strong and corporate balance sheets are in good shape. The wealth factor is kicking in and consumer purchasing power is on the rise.”

Exports still account for 40% of Asia’s gross domestic product, but export markets are becoming increasingly diversified, Ong says, with the U.S., European Union and China all major importers of Asian goods. As well, interregional trade among the smaller Asian nations — Hong Kong, Singapore, Malaysia, Korea and Taiwan — is also rising.

“All of the Asian countries are seeing exports to China grow rapidly,” says K.C. Lee, manager of Fidelity AsiaStar Fund, sponsored by Fidelity Investments Canada ULC of Toronto, in Hong Kong. “China has a voracious appetite for raw materials, components and semi-finished products that are turned into value-added finished goods in Chinese factories.”

In this new economic landscape, many Asian governments are boosting foreign-exchange reserves and strengthening their fiscal positions. These richer governments are spending more on infrastructure, thus creating jobs and fuelling the economic boom.

“The emerging countries are busy putting infrastructure in place,” says Wally Kusters, managing director of Barrantagh Investment Management Inc. in Toronto. “Many are still in the industrial phase of building a nation. The resulting demand for resources commodities is putting pressure on supply. What we’re seeing with the resources cycle is something that happens only once or twice a century. And, despite short-term turmoil, the long-term demand for resources is definitely there.”

Although rising costs for oil, coal and petrochemicals, as well as “soft” commodities such as agricultural products, can be inflationary, strong prices are beneficial to suppliers. Ong is finding opportunities in palm-oil producers in Indonesia and Malaysia as demand grows for the edible oil, particularly in China and India. Palm oil is also used in biofuel projects. Aside from resources, popular Asian investments include telecommunications and financial companies.

But investing in Asia in 2008 will not be risk-free. Asia has remained resilient in the face of slowing U.S. economic growth, but if the U.S. slides into recession, Asia’s export industries would feel the pain. Ultimately, slowing demand would result in job losses, slower wage growth and dampened consumer appetite. The pain would spill over into domestic industries. Tight global credit conditions and stock market nervousness could cause a drought in foreign capital, further hindering economic momentum.

“Huge foreign inflows have brought down the cost of capital in Asia, and the logical consequence of that has been a surge in economic activity,” says Lee. “It’s been a virtuous circle that could reverse itself if there is less capital flowing into these countries.”

A severe economic slowdown in the U.S. could also lead that country to introduce protectionist trade measures. “If the U.S. economy worsens, protectionism could rear its ugly head,” says David Harding, managing director of San Francisco-based Matthews International Capital Management LLC and manager of GGOF Asian Growth and Income Fund, sponsored by Toronto-based Guardian Group of Funds Ltd. “China would be hurt and there would be a chain reaction among countries linked to China. Even though there’s a lot going on domestically and less reliance on trade than in the past, no country is completely isolated.”

Inflation is another risk. It has been rising in China, India, Indonesia, Singapore and Taiwan. If inflation leads to significantly higher interest rates, that could dampen growth. Even without higher rates, the rising cost of goods and services could cool consumption.

@page_break@Here’s a look at Asian markets:

> India. After China, India is the Asian country with the fastest growth — slightly more than 9% annually. India is less dependent on exports, which make up about 15% of its GDP vs 40% in China. India has been on a roll for several years, as indicated by the stellar performance of Excel India Fund, sponsored by Mississauga Ont.-based Excel Funds Management Inc. (For the five years ended Nov. 30, 2007, it had an average annual compound return of 39%.)

After such a strong run, some investors in Asian markets are concerned about market valuations and are sitting on the sidelines waiting for an attractive entry point. Others are sifting through small- and mid-cap stocks for opportunities.

“India has reached the point of no return and is an exciting story,” says Chuk Wong, a member of the global equities team at Toronto-based Goodman & Co. Investment Counsel Ltd. and manager of Dynamic Far East Value Fund, sponsored by Dynamic Mutual Funds Ltd. , also of Toronto. “If anything, the current momentum could accelerate. The challenge is to find cheap stocks. Although the large companies are expensive, there is still value in second-tier situations. Housing is a strong story in India, as the middle class experiences rising income.”

But democratic India lacks the organization of China’s centralist government, and India’s inadequate infrastructure could lead to transportation bottlenecks as demand for goods increases. Additionally, the strong rupee could put a damper on some export sectors, particularly software and pharmaceuticals.

“India needs to invest in power, roads, water and ports,” says Tim Leung, head of Asian equities at I.G. Investment Management (Hong Kong) Ltd. “With the continuous improvements in government finance, there will be more capital devoted to infrastructure; that will be an additional driver of growth.”

Money managers see opportunities in Indian financial services stocks, as more people take on mortgages and loans and buy insurance. State Bank of India, LIC Housing Finance Ltd. and ICICI Bank are popular holdings. Also widely held is Bharti Airtel Ltd., the largest cellphone company in India, which has market penetration of about 20%.

> Singapore. Singapore is a booming financial centre, equivalent to Switzerland in Europe. A surge in immigration is driving up property prices. Justin Nightingale, assistant vice president of global equities at Montreal-based Natcan Investment Management Inc. , says the main holding of Altamira Asia Pacific Fund, which Natcan manages, is Singapore Telecommunications Ltd. The dominant player in the Singapore market, Singtel also has exposure to wireless businesses throughout Asia through stakes in other companies; it owns 30% of Bharti.

Although Singapore does not have oil reserves, it is home to the largest offshore oil-rig builders in the world, Keppel Corp. and SembCorp Marine Ltd., in which AGF’s Ong is invested.

>  South Korea. Korea has a strong export orientation, particularly cars and electronics. It is more sensitive than China to the ups and downs of the U.S. economy, but is shifting its export focus to China and India. In addition, the country’s construction and engineering companies have benefited from huge infrastructure spending in the Middle East. However, Pablo Salas, managing director at Trilogy Global Advisors LLC in Orlando, Fla., and manager of CI Emerging Markets Fund, sponsored by Toronto-based CI Investments Inc. , warns that softer oil prices could slow Middle East growth.

> Taiwan. Some managers are nervous about the Taiwanese market, which is dominated by technology stocks and strongly linked to the U.S. A Taiwanese presidential election this year is expected to bring a new business-friendly regime and closer ties with China, which would be favourable for growth.

> Hong Kong. Hong Kong is closely linked to China, with many Chinese companies listed on the Hong Kong exchange. Real-estate stocks are popular, including Cheung Kong Infrastructure Holdings Ltd. and Hong Kong Land Co. Hong Kong stocks and properties are expected to benefit as restrictions governing Chinese investors are relaxed.

Mark Lyn, vice president of EAFE equities for CIBC Global Asset Management in Montreal, likes Hong Kong Exchange and Clearing Ltd., which is prospering as capital markets develop and China-based companies migrate to Hong Kong. “Financial services companies typically grow faster than GDP as an emerging economy develops and creates opportunities,” he says.

> Thailand. Stocks in Thailand represent some of the best values in Asia, as a result of the pall cast by a military coup in 2006. However, December’s democratic election of a new government is expected to lead to greater stability and a focus on infrastructure spending.

“Thailand is a contrarian pick,” says Mark Grammer, vice president of investments at Toronto-based Mackenzie Financial Corp. and manager of Mackenzie Universal Future Fund. “Valuations are attractive and we are buying now in anticipation of renewed confidence.”

> Indonesia and Malaysia. These countries are large exporters of natural gas, as well as of palm oil used in food products and alternative fuels. The resources boom continues to stimulate these economies. Money managers are also finding opportunities in telecommunications and construction companies supplying services to the Middle East. IE