Economic growth slowed in the second half of 2004, reflecting the ongoing drag from net exports, and a rundown in inventories. With domestic demand weakening as households restructure their finances towards lower dissavings, GDP growth should remain subdued this year but pick up thereafter, helped by an acceleration in exports. The slowing economy, combined with firmer monetary conditions, is expected to keep inflation within the Reserve Bank’s 2 to 3% target band.

To create room for continued strong growth, the government should accelerate structural reforms to reduce the risks of capacity constraints proliferating. Reforms should focus on making wage bargaining more flexible, creating stronger incentives to labour market participation, removing disincentives to hiring, improving training and education, and promoting productivity growth by further strengthening competitive pressures in the economy.