Asian Development Outlook 2001 - Part I. Developing Asia and the World

Table of Contents

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I. Developing Asia and the World - Economic Developments and Prospects

Introduction and Overview

The World Economy

Developing Economies

Risks and Uncertainties

II. Economic Trends and Prospects in Developing Asia

III. Asia's Globalization Challenge

Asian Development Outlook 2001 : I. Developing Asia and the World - Economic Developments and Prospects

Developing Economies

Growth in the developing regions of the world improved to 5–6 percent in 2000 from less than 4 percent in 1999 and 3.5 percent in 1998. The DMCs as a group continued to be among the strongest performers. The strengthening of South-east Asia was particularly significant. Growth picked up from 3 percent in 1999 to 5.1 percent in 2000. Economic perfor-mance also improved elsewhere. After many countries in Latin America experienced weak or negative economic growth in 1999, the region revived to over 4 percent in 2000, led by strong performance in Mexico, Chile, and Brazil. In Africa, growth also accelerated as economic performance in South Africa strengthened, as did that of the oil exporters in the region—Algeria and Nigeria. In the Middle East, income rose more rapidly in 2000 than in 1999 on the back of higher oil prices in the second half of the year.

Notwithstanding the strong global economy, commodity price trends diverged in 2000. Agricultural prices increased by about 5 percent as did prices for some metals and minerals, led by strong markets for nickel, aluminum, and copper. Other metal prices remained unchanged or softened because of weak demand or high stock levels. Oil prices increased sharply in the second half of the year, reaching a peak of $35 a barrel before easing somewhat.

The Institute of International Finance estimates that net capital inflows to developing countries increased to just over $150 billion in 2000, only modestly higher than in 1999 and less than half the precrisis inflows of about $315 billion in 1997. Official flows to developing countries were negative in 2000, because official flows from international financial institu-tions remained low at $1 billion–$2 billion while net flows from bilateral creditors were negative as debt repayments from devel-oping countries were greater than new lending to them. Recent official debt relief measures for heavily indebted poor countries are expected to influence finances, mainly official, in 2001 and beyond.

Growth in developing countries in 2001 is likely to depend on several factors that will vary from country to country. In a globalizing world, the external environment plays a key role. Commodity prices continue to be a critical external factor for many countries in Africa and the Middle East and to a lesser extent for Latin American countries and DMCs. Petroleum is probably the most critical of these commodities, and if oil prices remain firm, oil exporters will continue to benefit (see Box 1.1). The likelihood of stable non-oil commodity prices will depend on the general strength of the world economy, weaker perfor-mance being generally associated with softer commodity prices. The pace of growth in industrial countries will also be a critical factor that will impact on developing countries, and exporters of manufactured goods will be among the first to suffer. Domes-tic macroeconomic and structural policies will be equally or, in some cases, more important, particularly where countries have deep-seated weaknesses. Policies and reforms are needed in some countries to address issues of governance, law and order, and civil society.

Africa and the Middle East

In the past few years, Africa and the Middle East have been exposed to a number of external factors—primarily develop-ments in commodity markets—that have had a significant impact on their economic performance. In 2000, buoyant oil markets gave a strong boost to oil producing countries in these two regions. The effect of higher prices and greater export volume had a widespread salutary effect on economic growth, domestic demand, fiscal health, and current account balances in these countries. Conversely, many of the non-oil producing countries suffered from adverse terms of trade as the price of their exports failed to keep up with the cost of imported oil and manufactured goods. Nevertheless, those non-oil producing countries that had adopted prudent macroeconomic and struc-tural policies managed to overcome this adverse effect and experienced accelerated growth. Those countries where govern-ment policies have been weaker and/or where the adverse terms-of-trade effect has been compounded by civil disturbance or drought performed poorly.

Economic growth resumed in Saudi Arabia and other Gulf and Middle East oil exporting countries in 2000. These coun-tries have also begun to benefit from structural reforms under-taken, when petroleum prices were much lower, to stimulate the non-oil private sector. Measures have included the privatization of some utilities (including telecommunications) and the adoption of regulations designed to attract foreign direct investment (FDI) and the private sector generally. In Egypt, growth slowed a little in 2000 from the 1999 level. Fiscal and monetary policies were tightened in response to a deterio-rating external payments position, as seen in a loss of foreign reserves and pressure on the exchange rate.

Within Africa, output growth accelerated to about 3 per-cent, from around 2 percent in 1999, as a result both of more buoyant markets for some commodities, particularly petro-leum, and the effects of implementation of better macroeco-nomic policies and structural reforms. The two largest economies in the region—Nigeria and South Africa—recorded growth of about 3 percent, the former aided by higher oil prices and the latter by greater external demand and growing interna-tional competitiveness.

Several other African countries also grew more rapidly as they effectively implemented macroeconomic and restructuring policies. However, some countries suffered from a range of constraints including weak commodity prices, drought, and civil conflict. Capital inflows to the region remained small in 2000. Official inflows were negative for the fourth year in a row at $1.7 billion (due to loan repayments) while private flows fell from $10 billion to around $7 billion.

Box 1.1 Oil and Energy Issues in Developing Member Countries

Oil prices have recently exhibited considerable volatility. Having increased from a little over $10 a barrel in February 1999 to $30–$35 a barrel in November 2000, they have come down to a range of $24–$30 a barrel in January–February 2001. The rapid increase in oil prices initially reflected production cutbacks among major oil producing countries in 1999. This was accompanied by high and persistent world demand for oil, due to the strong rebound in economic activity in Asia and continued robust growth in the US economy through mid-2000. As a result, commercial inventories of oil were drawn down to their lowest levels since the 1970s.

In April 2000, the Organization of Petroleum Exporting Countries (OPEC) reversed its production cuts of the previous year and adopted a target price range of $22–$28 per barrel. Despite subsequent increases in oil production, prices remained above the upper limits of OPEC’s price band until the end of the year. The decline in prices in early 2001, however, coincided with a drastic cut in Iraqi oil production because of a dispute with the United Nations over its oil-for-food program. In an attempt to maintain prices, OPEC announced another production cutback in January 2001.

Prospects for world oil prices remain subject to considerable uncertainty arising from both supply and demand factors. On the supply side, immediate prospects depend on the extent to which OPEC members adhere to their reduced production quotas and the extent to which higher prices reactivate oil wells capped during the oil price slump of 1998. The forecasts for non-OPEC production indicate that output will grow slowly. At present, nearly all oil producing countries, except Saudi Arabia, are producing at or near full capacity. Moreover, in March 2001 OPEC agreed to restrict production to maintain prices within its target band. On the demand side, while the onset of warmer weather in the northern hemisphere will inevitably lead to a downturn in demand, prospects for the year are highly dependent on how much the global economy in general—and the US economy in particular—slows. Any such slowdown will, to some extent, be offset by the oil companies’ need to replenish depleted stocks of oil. Barring supply disruptions caused by ongoing tensions in the Middle East, a moderate decline in oil prices is assumed, in line with oil futures prices. However, if oil prices remain higher than they are expected to, then this would have several adverse implications for global economic prospects, as follows.

Higher oil prices can affect the global economy through various channels. The initial impact is likely to be felt on the trade balance of both oil exporting and oil importing countries. The resulting income transfer from oil importers to oil exporters is likely to lead to a fall in global demand because oil importing countries have a higher propensity to spend than oil exporting countries. Higher oil prices can also have an impact on price inflation and economic growth. Inflationary pressures arising from higher costs of production can feed into a wage-price spiral and lead to higher interest rates. This could reinforce the negative effects of terms-of-trade shocks on output for oil importing countries and lead to lower GDP growth. Moreover, if governments derive revenue from imported oil and/or subsidize the domestic use of oil, this could complicate fiscal management, especially if higher prices persist.

Many analysts, however, feel that the world economy today can better cope with the adverse consequences of an oil price shock than it did during the previous oil price surges of 1973/74, 1979/80, and 1990, when sharp rises in oil prices led to higher inflation and global recession. In real terms, prices today are one third below their levels in the 1990s and one half of their levels in the 1970s. Oil also now accounts for a smaller proportion of world production and consumption. This is especially true for the industrial countries.

Since the 1970s, due to energy conservation, a switch to other fuels, and technology developments, industrial countries have greatly reduced their dependence on imported oil. At the same time, their services and information, communications, and technology sectors (which have a lower oil intensity of production) have increased their share of GDP at the expense of manufacturing (with a higher oil intensity). This has been facilitated by the relocation of manufacturing activities to lower-cost developing countries. As a result, industrial countries now use only about half as much oil for every dollar of GDP compared with the early 1970s. In developing member countries (DMCs), although the growth in consumption of natural gas has outpaced that of oil in recent years, their share of global oil consumption, nevertheless, increased from 17 percent in 1980 to 26 percent in 1998, due in part to rapid growth in manufacturing activity. As a result, the oil intensity of production in DMCs has remained broadly constant since the early 1970s. As DMCs have relatively few oil producers, they are likely to suffer more from an increase in oil prices than industrial countries.

According to IMF’s World Economic Outlook of September 2000, a sustained $5 a barrel increase in the price of oil over a baseline figure of $26.53 a barrel in December 2000 would, after one year, lead to a fall in GDP of 0.2 percent for the major industrial countries while inflation would rise by 0.2–0.4 percent. For developing countries in Asia, GDP would decline by 0.4 percent, inflation would rise by 0.7 percent, and the current account balance would deteriorate by around 0.5 percent of GDP. These aggregate figures, however, conceal large differences between individual countries within Asia. While slower growth will undoubtedly be a setback for a recovering Asia, for a number of the newly industrialized economies and Southeast Asian net oil importers currently enjoying large current account surpluses and subdued inflation, the impact of higher oil prices is unlikely to be a cause of concern. However, for some of the South Asian countries running large current account deficits, further deterioration of their external accounts and output losses due to higher oil prices could have potentially serious effects.

Latin America

Growth in Latin America rebounded strongly to around 4 percent in 2000, from negligible growth in 1999. The region benefited from a combination of strong growth in the US, higher prices for some commodities, and generally sounder macroeconomic policies and performance, particularly with respect to inflation. The two largest economies in the region—Mexico and Brazil—performed well in 2000, growing at about 7 percent and 4 percent, respectively. Export growth was very strong in both countries. Mexico’s buoyant economy was led by soaring exports, primarily of oil, to the US and by strong investment growth. Brazil benefited from greater export competitiveness following its currency depreciation in early 1999. The Brazilian Government improved its fiscal situation as stronger consumer and investment spending resulted in higher tax receipts. Argentina, the third largest economy in the region, began to recover from a severe recession in 2000 but growth was slower than expected leading to continued pressure on the budget and to less favorable terms in international capital markets. This resulted in severe financial pressures toward the end of the year. Venezuela benefited from higher oil prices, while the economies of Chile and Peru continued to perform well. Inflation in the region abated somewhat in 2000 as many countries have adopted either inflation targeting or policies with a strong inflation containment component. The current account deficit decreased slightly for the region as a whole.

Asian and Pacific Developing Member Countries

The DMCs’ recovery from the financial crisis of 1997/98 strengthened in 2000 (see Table 1.1). The strong performance reflected the favorable external environment through most of 2000; expansive macroeconomic policies; competitive exchange rates; and, in varying degrees, progress in financial and corporate restructuring, and in economic reforms. Higher oil prices toward the end of the year had different effects on oil exporters and importers, but on balance were a negative factor for growth, and in some countries pushed up inflation slightly. In several countries, the impact of oil prices on inflation was offset by the influence of moderate food prices.

Many DMCs were well positioned in 1999 and 2000 to take advantage of the rapid growth in import demand from industrial countries, especially the US. GDP growth for the region was over 7 percent for the whole of 2000, up from just over 6 percent in 1999, though the pace slowed during the second half of the year. Domestic demand began to strengthen in a number of economies relative to the preceding two years. Hong Kong, China; and Singapore led the continued strong performance of the region, with economic growth in 2000 of 10 percent or more. In Indonesia, Philippines, and Thailand, recovery continued but remained somewhat fragile due to incomplete structural reforms, political uncertainty, and generally weak private investment. Growth in the PRC and India, where the impact of the Asian crisis was more limited, continued at a rapid pace, primarily due to strong domestic demand and buoyant export performance. Strong agricultural performance took GDP growth to its highest rate in four years in Pakistan, while in Bangladesh, Nepal, and Sri Lanka economic growth was also higher. Agriculture also played a major role in boosting growth in Bangladesh and Nepal, while industry was an important source of growth in Sri Lanka. Most of the economies in the Central Asian republics, Azerbaijan, and Mongolia grouping benefited from improved economic performance in the Russian Federation as well as from higher prices for oil and natural gas, which are the leading exports for several of them. The Pacific DMCs showed weaker performance due to political problems in some countries and continued softness in world nonenergy commodity prices. In the second half of 2000, many of the larger DMCs started slowing as GDP growth in industrial countries, particularly the US, slowed.

Inflation was benign in 2000 for most DMCs. In the NIEs, except Hong Kong, China, prices rose slightly faster than in 1999 as a result of higher oil prices but, even so, inflation remained at less than 2.5 percent in Korea; Singapore; and Taipei,China as macroeconomic policies remained prudent and money supply growth was held in check. In Hong Kong, China, the consumer price index continued its deflationary trend due to weakness in property rental prices, but the rate of decline showed signs of moderating. In the PRC, a strengthening of private consumption reversed the 1998–99 deflationary trend; the consumer price index rose by 0.4 percent. In Southeast Asia (except the Lao PDR and Myanmar), despite a small pickup in inflation in the last quarter of 2000, overall inflation remained low and relatively stable. In the Central Asian republics, Azerbaijan, and Mongolia; Lao PDR; and Myanmar, inflation remained high, primarily due to the effect of currency depreciation on import prices and accommodative monetary policies. In South Asia, India experienced somewhat higher inflation due to deregulation of fuel prices and the depreciation of the rupee. More prudent fiscal and monetary management was generally important in holding down inflation elsewhere in this subregion.

Several DMCs recorded double-digit export growth in 2000. The continuing global demand for goods related to information and communications technology (ICT) led to a surge in exports from India; Korea; Malaysia; Singapore; Taipei,China; and Thailand. Rising international oil prices stimulated exports from Indonesia and many of the Central Asian republics and Azerbaijan, while the PRC benefited from higher demand for its labor-intensive manufactured goods. Notwithstanding strong exports, more rapid growth of imports in 2000 led to a narrowing of current account surpluses in many DMCs. These surpluses were in some cases used to finance both external debt repayments and a further buildup in reserves, albeit generally at a much slower pace than in 1999.

Equity and currency markets declined significantly in 2000 in many DMCs. Externally, rising interest rates, slower growth in the US in the second half of the year, and the popping of the technology bubble triggered downward adjustments in equity markets. The response of Asian equity markets to the worldwide correction in prices of ICT stocks, particularly the fall in the NASDAQ index, was especially strong (see Figures 1.3 and 1.4). Domestic considerations also, in some cases, dampened investor enthusiasm and confidence in the region. These included incomplete restructuring of banks and corporations, limited progress in structural reforms, and perceived heightening of political risks in some countries. Domestic currencies weakened in the region due to concerns over an international growth slowdown and any resultant impact on regional growth through the export sector.

NIEs and ASEAN-4 Countries

The NIEs recorded the strongest growth performance as a group in the region in 2000, with GDP growth picking up to 8.4 percent. Growth also picked up in three of the ASEAN-4 countries (Indonesia, Malaysia, and Philippines).

In terms of GDP growth, Hong Kong, China; Singapore; and Taipei,China performed well in 2000. GDP growth accelerated from 4.8 percent in 1999 to an exceptionally strong 7.9 percent in 2000. At the same time, the variation in economic performance was smaller relative to that observed in 1999. Hong Kong, China and Singapore recorded similar growth rates in 2000, with that of Taipei,China somewhat lower. Buoyant exports, led by electrical and electronics products, were the primary growth engine as the rate of export increase more than doubled to around 20 percent in these three economies. Domestic demand also accelerated as consumer and investor confidence rose. Labor market conditions improved and property prices saw some recovery, while spending on new plant and equipment in the technology sectors increased. Imports also picked up, reflecting a combination of restocking of intermediate inputs and rising demand for consumer goods.

Inflation rose a little in Singapore and Taipei,China as a result of higher oil prices in the latter part of the year, combined with faster growth and falling unemployment, but remained relatively low. In Hong Kong, China prices continued to fall as a result of flat or declining prices for retained imports and consumer goods as well as continued slack in the economy. Strong growth generally helped Singapore increase its fiscal surplus, and Taipei,China reduce its fiscal deficit, though the budget balance in Hong Kong, China deteriorated slightly from a modest surplus to a small deficit. As exports of goods and services were generally larger than imports, the current accounts were in surplus in 2000, though at slightly lower levels than in 1999, ranging from 23.6 percent of GDP in Singapore and to 2.4 percent in Taipei,China.

The economic recovery in the five countries most affected by the Asian financial crisis (Indonesia, Korea, Malaysia, Philippines, and Thailand) remained relatively strong in 2000 and has taken the form of a “V” shape. Growth accelerated in Indonesia, Malaysia, and Philippines but fell slightly in Korea and remained virtually unchanged in Thailand. Economic performance was the result of a combination of domestic and external factors. Domestically, accommodative monetary policy, as reflected in low interest rates and more competitive exchange rates, as well as government budget deficits, generally provided a stimulus. The recovery was also supported by the implementation of measures to address corporate and financial sector problems. These measures have generally helped reduce the level of nonperforming loans (NPLs). Additional supportive external factors included the strength of the US economy. Korea remained the fastest-growing economy of the group, mainly due to a surge in fixed investment spending and rapid growth in manufacturing. In the other four countries, the recoveries varied in strength; in Malaysia growth picked up to over 8 percent, while in Indonesia, Philippines, and Thailand it was around 4–5 percent.

Despite relatively strong growth, considerable weakness in domestic demand was still in evidence in Indonesia, Philippines, and Thailand. Conversely, domestic demand was somewhat stronger in Korea and Malaysia, where both consumption and gross fixed capital formation increased and the recovery has been reinforced by greater consumer confidence. Private investment, particularly FDI, was somewhat weak due to a combination of factors that included excess capacity in nonexport industries and weak corporate sector profitability related to incomplete corporate and financial restructuring (see Box 1.2). Domestic equity markets moved down with equity markets in the US in 2000, alongside some net capital outflows or slowing of inflows.

Despite firmer prices during the last quarter of 2000, inflation generally remained low and stable during the year in the five countries due to moderation of food prices and continued excess capacity in certain sectors. Toward the end of the year, weakness in the currencies of several of these countries added somewhat to price pressure.

Continued strong global demand for electronic goods led to a surge in exports from Korea, Malaysia, and Thailand in 2000, while rising international oil prices stimulated exports from Indonesia. Export growth ranged from about 9 percent in the Philippines to 28 percent in Indonesia. Exports of electronic products softened toward year-end, as the US economy slowed and global demand for electronics weakened. While the current account surplus of Indonesia and the Philippines increased, those of the other economies narrowed.

Cambodia, Lao PDR, and Viet Nam

Against a background of improved domestic macroeconomic management and economic reforms, economic growth in these three countries was affected to some degree by developments in the global economy in 2000. Higher world oil prices and a robust industry sector helped Viet Nam achieve a stronger rate of growth in 2000 than in 1999 while seasonal floods hampered otherwise good performance in Cambodia. Strong agricultural performance made an important contribution to growth in the Lao PDR. Greater price stability among the three countries was generally achieved through prudent monetary and fiscal policies, a fall in world food prices, particularly of rice, and generally good agricultural performance. Fiscal deficits worsened in all three countries, but only slightly in Cambodia and Viet Nam. Export growth was robust, led by crude oil in Viet Nam and by garments in Cambodia and the Lao PDR. However, import growth was also strong and the current account balance weakened to a smaller surplus in Viet Nam and deteriorated to a substantially larger deficit in Cambodia.

Box 1.2 Financial Sector and Corporate Restructuring in Five Crisis-Affected Countries

Since the onset of the Asian financial crisis in July 1997, all of the five most seriously affected countries (Indonesia, Korea, Malaysia, Philippines, and Thailand) have made significant progress in the immense task of financial and corporate sector restructuring. The focus of their efforts has been on resolving the problem of insolvent financial institutions by closure, merger, or recapitalization; addressing the corporate debt overhang; and improving corporate governance. The broad principles of financial and corporate restructuring have been similar, but the actual patterns of implementation have varied. Indonesia, Korea, and Malaysia have adopted restructuring programs that have stressed coordination by the central government. They have established central agencies to manage nonperforming loans (NPLs) and to carry forward the recapitalization process. The Thai Government has followed a more market-oriented approach, though it has restructured public banks and finance companies and absorbed some of their losses. The Philippines adopted no explicit set of restructuring measures since it was, to some degree, less affected by the crisis.

The first objective in all the countries was to resolve the problems of financial institutions in trouble. Banks were mandated to meet international standards of capital adequacy, loan classification, loan-loss provisioning, accounting, and disclosure. Also, many nonviable institutions were closed, but the viable ones were merged or recapitalized through the injection of public money.

Financial restructuring moved forward on several fronts in 2000. The Financial Supervisory Service of Korea introduced new and more stringent criteria for classifying NPLs in December 1999, leading to an increase in the NPL ratio from the one based on the old criteria. Reflecting restructuring, however, the NPL ratio for Korea is now the lowest among the five countries. Together with Malaysia, Korea now has an NPL ratio for commercial banks of less than 10 percent. During 2000, debt restructuring through asset management companies (AMCs) made further progress in Korea and Malaysia. The Korea Asset Management Corporation had purchased more than 50 percent of the banking system’s NPLs by July 2000 and disposed of 40 percent of those it had acquired. In

Malaysia, Danaharta—the agency set up to purchase and rehabilitate the financial sector’s bad debt—had acquired a little more than 40 percent of NPLs by August 2000, amounting to about 15 percent of the country’s GDP. It is estimated that, as of June 2000, it had disposed of 61 percent of the NPLs under its jurisdiction.

In Indonesia, the NPL ratio has also fallen. As of June 2000, it was reported to be about 30 percent for the country’s banking system as a whole, down from a peak of 70 percent. More than 75 percent of the total NPLs in the banking system, amounting to 60 percent of GDP, are now under the control of the Indonesian Bank Restructuring Agency. However, uncooperative debtors, and an inadequate legislative and regulatory environment have hampered the recovery of asset values in the country. As of June 2000, the Agency had disposed of only 0.35 percent of acquired NPLs.

In Thailand, progress has been made in reducing NPLs, which had declined from a peak of about 48 percent in May 1999 to 18 percent by December 2000. However, for two reasons, the resolution of the NPL problem is incomplete and remains a significant challenge to the Government. First, the sharp decline in NPLs was largely due to the transfer of some NPLs to AMCs, which were created to remove bad loans from bank balance sheets. If these NPLs were included in the calculation of the NPL ratio, together with new NPLs and reentry NPLs, the NPL ratio would be around 30 percent rather than 18 percent. Moreover, as of December 2000, state-owned commercial banks and finance companies had significantly higher NPLs than private commercial banks, averaging around 22 percent and 25 percent, respectively. Second, as economic growth has slowed, some restructured loans have resurfaced as reentry NPLs. Some commercial banks were reluctant to accept losses and tended to simply reschedule the payments. New NPLs have continued to emerge, particularly in those industries that continue to struggle, such as real estate and construction. So, though Thai banks have made significant progress in meeting capital adequacy standards, additional capital may be required.

Corporate restructuring in these five countries also progressed through government-sponsored voluntary workout arrangements and outside this framework. But, in many countries, much more needs to be done. In Korea, the restructuring of the top four chaebol is moving ahead. They have all met the overall requirements of the Capital Structure Improvement Plans for 1999. Some progress has also been made in the restructuring of smaller chaebol and firms. In Thailand, by end-September 2000, the participant debtors in the Corporate Debt Restructuring Advisory Committee owed about B2.6 trillion in loans. About 43 percent of the loans referred to the Committee had been resolved. Although many large loans have been voluntarily resolved, some have not. Indonesia has seen some progress in government-supervised debt restructuring. In August 2000, the Jakarta Initiative Task Force reported the completion of 24 (out of 67 active) debt-restructuring cases. The completed cases involved $5.2 billion in debt, accounting for almost 40 percent of the total value of active cases. This is a substantial improvement on the less than $1 billion debt restructured as of February 2000. Particularly helpful was the adoption of time limits for mediation procedures and the improvement in regulatory incentives for corporate restructuring.

In the case of formal insolvency, recent data are not available. But earlier reports suggest that few bankruptcy cases have been filed in these countries and even fewer cases completed. Gaps in bankruptcy legislation and weak institutional capacity in some countries suggest that formal resolution of debts may continue to be a slow process.

Source: Adapted from Regional Economic Monitoring Unit, Asian Development Bank.

PRC and India

During and following the Asian crisis, the PRC and India maintained generally robust growth, despite a slowdown in exports. This was mainly because both economies have relatively low export-to-GDP ratios while capital account restrictions cushioned them somewhat against sharp currency and asset market fluctuations in the region.

The PRC continued to show strength in 2000. Real GDP growth was 8 percent, up from 7 percent in 1999, driven by an acceleration in industrial growth. However, agriculture suffered from a severe drought and grain output fell by 8 percent. The deflationary trend experienced in the previous two years was largely arrested and the consumer price index experienced virtually no change. The fiscal deficit rose to about 2.8 percent of GDP compared with 2.1 percent in 1999. Money supply growth provided sufficient funds for continued rapid expansion, with M2 rising by 12.3 percent, slightly lower than the rate in 1999. Further steps toward liberalizing the financial sector in preparation for entry into the World Trade Organization were taken, e.g., liberalizing interest rates on foreign currency loans and large deposits. With strong growth in the US economy during the first half of the year and the recovery of the crisis-affected countries in Asia, export growth surged to 27.8 percent. The rapid increase in input needs of exporting industries and the industry sector boosted import growth to 36.8 percent in 2000. The current account surplus continued moving downward, falling to 1.5 percent of GDP. This decline was due to the chronic deficit in the services balance and a narrowing of the trade surplus. FDI fell moderately during 2000 as a result of the lagged effects of the Asian financial crisis, resulting in a substantial drop in contracted FDI in 1998–1999. However, approved foreign investment rose by 25 percent. With foreign exchange reserves of about $160 billion, external debt of $156 billion, which is mostly of medium- and long-term maturity, and a debt-service ratio of about 8 percent, the external situation continues to be very strong.

In India, GDP growth was around 6 percent in 2000, led by a strong services sector. The agriculture sector grew more slowly, by 0.9 percent, as production was adversely affected by poor weather. The inflation rate rose temporarily to 7 percent from 3.3 percent in the previous year, largely as a result of higher fuel prices following deregulation and the effect of higher world oil prices. Measures to bring spending under control were generally successful and the tax base broadened. The central Government deficit is likely to be contained within the budget estimate of 5.1 percent of GDP. Rising interest rates in the US in the first part of the year resulted in an outflow of funds and a consequent decline in the rupee against the dollar. In response, the Reserve Bank of India raised interest rates moderately in July and tightened monetary conditions. Nevertheless, commercial sector demand for credit continued to grow, mainly as a result of oil companies’ greater financing needs to pay for higher import costs. Exports maintained their strong performance, growing by 17 percent in 2000. Robust economic growth in the US and the rest of Asia continued to increase demand for Indian manufactured goods. Software exports, while accounting for only 10 percent of total exports, have been growing at 50 percent year on year. Imports also grew strongly as a result of higher oil import costs and a more rapid pace of capital imports. The overall current account deficit was 1.3 percent of GDP in 2000 compared with 0.9 percent of GDP in 1999.

Bangladesh, Nepal, Pakistan, and Sri Lanka

In these four countries, GDP growth generally accelerated in 2000. Growth in Bangladesh and Nepal was higher than at anytime since the mid-1990s, and was higher than in the previous year in Pakistan and Sri Lanka. Stronger agriculture was largely responsible for the enhanced performance. Bangladesh achieved food self-sufficiency for the first time in many years, and Pakistan and Nepal turned in bumper harvests. Except for Sri Lanka, inflation generally moderated on the back of stable food prices and prudent monetary management. Large fiscal deficits, however, remained a major concern in several of these countries. The budget deficit, excluding transfers, stayed stable in Nepal but rose in the other three countries to at least 6 percent of GDP—in Sri Lanka reaching as much as 10 percent of GDP. External trade played an important role in the stronger economic performance of this region, with rapid growth in exports of garments and textiles. Buoyant exports resulted in a general improvement in the countries’ balance of payments, and the current account deficits fell in some of them.

Central Asian Republics, Azerbaijan, and Mongolia

The economic turnaround in the Russian Federation from 1999 and the rise in international energy prices helped generate strong aggregate GDP growth of below 5 percent for this group in 1999 (excluding Mongolia) that improved further to 8 percent in 2000. Growth performance would have been even more impressive if the agriculture sector had not suffered a severe drought that affected both the cotton crop, a major export item, and food grain production in some of these countries. In Mongolia, not an oil exporter, circumstances were somewhat different as economic performance fell far below potential due to the impact on agriculture of a severe drought. GDP growth was close to zero compared with average growth of 3.6 percent between 1997 and 1999.

Aside from Mongolia, in 2000 the average level of inflation in these countries fell to 15.2 percent though this level is still high. Generally, this reflected the positive effects of exchange rate stability and appropriately restrained monetary policies. In Mongolia, on the other hand, inflation accelerated to double-digit levels as an expansionary fiscal and monetary stance was adopted to offset the poor performance of the economy.

Higher revenues from the oil sector and efforts at improving public expenditure management and tax administration have helped the countries improve their fiscal performance. Fiscal deficits on average declined from 5.6 percent of GDP in 1999 to 2.8 percent in 2000. Taking advantage of high international oil and gas prices and greater access to pipelines and other supply outlets, this group’s export earnings increased by 0.4 percent and 25 percent in 1999 and 2000, respectively. This enabled many of the countries to improve their external positions, as reflected in a decline in current account deficits, a buildup of international reserves, and a significant improvement in external debt-servicing ability. However, in Mongolia the current account deficit deteriorated.

Pacific DMCs

The economic recovery in the Pacific that began in 1999 was not sustained in 2000 due to political instability and social unrest in the Fiji Islands and Solomon Islands. In addition, growth in the largest economy in the subregion—Papua New Guinea—slowed significantly in 2000 with weak performance in agriculture and industry. As a result, the growth performance of the Pacific DMCs as a group declined by about 2 percentage points in 2000. Growth was generally led by tourism or construction activity. Inflation in several countries rose as a result of weakening currencies and increased world oil prices.

Government deficits widened in five of the Pacific DMCs for various reasons, including a fall in revenue, political instability, and social unrest, or the launch of large development projects. In contrast, budget outcomes improved in the other countries. In all but three Pacific DMCs, the overall balance-of-payments position deteriorated, due mainly to higher oil costs.

Prospects for 2001 and 2002

Compared with GDP growth of just over 7 percent in 2000, growth in the DMCs is expected to slow to 5.3 percent in 2001 before picking up to just over 6 percent in 2002. The anticipated slowdown reflects primarily a sharp deceleration of export growth to single-digit levels in 2001 and spillover effects to domestic economic activities. Private consumption is expected to moderate in 2001 as the income effects from the export sector spread during the year. Monetary policy is generally expected to be accommodative. Fiscal policy will be constrained by the need to reduce fiscal deficits in some countries, but it can provide support for domestic demand in others.

The projections for 2001 have been revised from the ADO 2000 Update to incorporate the effects of the sharper than expected slowdown in the global economy that is under way, as well as the stronger outturn for 2000. On balance, the ADO 2001 projections imply that the level of GDP in the DMCs at the end of 2001 will be around 0.8 percent lower than implied by the ADO 2000 Update and that growth in 2001 will be half a percentage point lower than the ADO 2000 Update.

The ADO 2001 projections are based on a number of assumptions about the external environment. First, the US economic slowdown will only be brief with the US recovering to close to its long-term trend growth in 2002. Growth in the euro area and Japan is expected to slow marginally, though still maintain momentum in 2001 and 2002. (The risks to this baseline set of assumptions are discussed in detail in the next section.) Second, growth in world trade volume is expected to drop quite sharply in 2001 and then level off in 2002, while oil prices are assumed to remain in the $23–$28 per barrel range in 2001 and 2002. Third, macroeconomic policies in industrial countries are assumed to be supportive of the recovery to stronger growth in 2002 through an accommodative monetary and fiscal stance.

In Hong Kong, China; Singapore; and Taipei,China export growth is expected to slow sharply in 2001, with a negative impact on aggregate supply. Domestic demand growth will be weaker than in 2000, particularly in electronics-related private investment. Monetary policy is expected to remain accommodative. Strong trading relationships with the PRC will help offset the impact of slower exports to the rest of the world. GDP growth in these economies is forecast to decelerate to about 4.8 percent in 2001 before rising to around 5.7 percent in 2002.

In the five crisis-affected countries, export performance is likely to lose much momentum in 2001 as the global environment becomes less favorable and the boom in electronics moderates. As export growth slows, manufacturing and services will be adversely affected. The extent of the impact on domestic demand will depend both on the extent of the slowdown and on export dependence (see Box 1.3). While the use of fiscal policy is generally constrained by public debt burdens, monetary policy is expected to be accommodative to cushion the slowdown. GDP growth is forecast to decelerate sharply to below 4 percent in 2001 from 6.8 percent in 2000, and to recover to over 5.1 percent in 2002 (comparative forecasts for these countries are shown in Figure 1.5).

Driven by domestic demand growth, the PRC economy is forecast to slow somewhat, but still grow by over 7 percent in 2001 and 2002 led by strong performance in the industry and services sectors. Inflation is likely to be modest, investment rates high, and foreign investment strong. Export growth should slow as the global economy weakens and imports accelerate during the time that entry into the World Trade Organization brings a more liberal trade policy environment in its wake.

Box 1.3 Effects of a US Slowdown on DMC Exporters

A slowdown in the US economy might have a significant effect on DMC exports beyond the impact measured by the proportion of total exports destined for the US market. This is because many of the DMCs are heavily involved in intraregional trade in electronic components. In the recession of 1991, when US GDP fell by 0.5 percent, its imports from Asia fell from a high of 9.8 percent growth (year on year) in the second quarter of 1989 to a contraction of 2.7 percent in the first quarter of 1991. Will the current slowdown in the US economy have a similar effect? The changes in the intervening decade to the structure of Asian exports to the US should be considered. The major exports from DMCs to the US are now manufactured goods, a large portion of which are electronics. These products fall within three broad classifications: industrial electronics (mainly microchip testing equipment), electronics components and parts (mainly semiconductors and microprocessors), and consumer electronics (predominantly personal computers). The box table gives the shares of electronics in total exports and of these three classifications in electronics exports. Except for the PRC and Indonesia, where electronics exports are a small fraction of total exports, the economies shown are strongly linked to the global and US electronics cycle.

In seven of the nine Asian economies reviewed, at least two thirds of electronics exports are in electronics components and parts. Only the PRC and Indonesia are concentrated in consumer electronics (85 percent) while Hong Kong, China; Korea; Singapore; and Taipei,China have 10–18 percent in industrial electronics. Thailand is roughly split between consumer electronics and electronics components. Forecasts for the next three years suggest that electronics components will continue to grow at a healthy rate but growth will fall from close to 40 percent in 2000 to 20–30 percent a year in 2001 and 2002. The growth in consumer electronics has been much slower, and is also likely to fall in the next two years.

Simulations of possible slowdown scenarios in global demand for these three subsectors suggest that export growth in Malaysia and the Philippines will be most adversely affected by a slowdown in the global demand for electronics, as they are heavily focused on electronics components. The PRC and Indonesia would be the least vulnerable, since electronics represent a smaller share of total exports. Taipei,China and Korea, followed by Malaysia and Singapore, would suffer the biggest reductions in GDP growth.

Growth in India will depend largely on the performance of agriculture and on the continued efficiency gains in the industry sector as a result of policy reforms. While somewhat shielded from the global economic slowdown, exports will still be adversely affected. Assuming normal weather conditions and relaxed monetary policy, GDP growth in India for 2001 and 2002 is forecast to remain in the 6–7 percent range. In most of the other countries, the outlook is for slightly slower growth. Growth for South Asia as a whole should remain unchanged in 2001, at about 5.8 percent, improving somewhat in 2002.

In the Central Asian republics, Azerbaijan, and Mongolia, economic growth is expected to slow in 2001 and 2002 as oil prices soften somewhat and as demand slackens in the Commonwealth of Independent States for these countries’ exports. This forecast assumes that the various governments will adopt further policy reforms to support growth and further liberalize their economies. Growth is projected to be in the range of about 3–5 percent in 2001 and 2002.

In Cambodia, Lao PDR, and Viet Nam, growth will depend on strength in agriculture, export prospects for garments, and a furtherance of stabilization measures to contain fiscal deficits and maintain stable prices. Growth is forecast at about 5–7 percent in 2001 and 2002.

In the Pacific DMCs, a gradual return to normalcy in the Fiji Islands and Solomon Islands and improved prospects for Papua New Guinea should provide a foundation for more sustained growth. The subregion is expected to grow by 3–5 percent in 2001 and 2002.

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