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p. 2 of 54 BACK | NEXT 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

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Introduction and Overview

Growth in the world economy accelerated to an impressive 4.8 percent in 2000, more than a percentage point higher than in 1999 and the fastest in over a decade. The very strong per-formance for the year as a whole, however, masks a significant downshift in the second half as the United States (US), in particular, reached a cyclical peak and began to slow. As a result, the world economy entered the current year with considerably less growth momentum. Notwithstanding considerable uncertainty about near-term prospects, the Asian Development Outlook (ADO) 2001 is cautiously optimistic that the world economy will experience only a relatively shallow and short-term slowdown in 2001 before returning to trend growth in 2002. On the other hand, there are some significant downside risks in the near-term outlook. Should these materialize, a much less favorable outcome may be possible.

The rebound in global growth from the slowdown that occurred in 1997/98 — induced by the Asian financial crisis that began in 1997 and the Russian crisis of 1998 — picked up momentum in the first half of 2000 (see Figure 1.1). The main driver continued to be the US, where the growth of domestic demand accelerated further, but the expansion also started to become more broad based. Growth in both the euro area and Japan picked up while activity remained strong, or strength-ened, in many other industrial countries, including Australia, Canada, and United Kingdom (UK).

In addition, a number of developing countries in Latin America, Africa, and Europe began to share in the favorable global conditions. Following its sharp slowdown in 1999, the Russian Federation experienced a bounce back in 2000 with favorable implications for the transition economies of Europe and Central Asia. Those Asian countries affected by the 1997/98 crisis also continued their strong recoveries in early 2000, growing, in some cases, at high single-digit rates or faster. Growth also remained strong in the People’s Republic of China (PRC) and India. World trade expanded very rapidly during the first half of the year, as exports, especially of technology products from Asia, grew in line with “new economy” fervor.

During the second half of the year, the world economy began a cyclical slowdown. This was particularly pronounced in the US, where domestic demand growth began to shift to a much more moderate pace following several years of high growth. Japan’s economy grew more rapidly than in 1999 but showed some signs of weakness after midyear. Growth also began moderating in several of the developing member countries (DMCs) of the Asian Development Bank (ADB) with close trading links to the US. Growth, however, held up or accelerated in much of western and eastern Europe, as seen in continued strength in the more buoyant euro area and robust growth in the Russian Federation.

A contributing factor to the slowdown in the global economy was the steep rise in world oil prices. After extreme weakness early in 2000, oil prices rebounded and reached a peak of over $35 a barrel in September, before falling somewhat. While the effects on inflation were generally small, the implied terms-of-trade losses for net oil importing countries may have shaved 0.2–0.5 percent off global growth in 2000 and early 2001. Among DMCs, significant net oil importers such as India and the Republic of Korea (Korea) were particularly hit, while net oil exporters such as Indonesia and the Central Asian republics benefited.

Despite resource use rising to high levels in several major industrial countries, inflation generally remained subdued in 2000. Average inflation in the major industrial countries continued at its lowest rate for several decades before rising modestly in the second half of the year in response to a run-up in world oil prices. Among developing countries, inflation was also generally moderate.

Through most of the year, the dollar strengthened further in foreign exchange markets as the large and growing US cur-rent account deficit continued to be more than adequately financed by large capital inflows. In addition to strengthening against many developing country currencies — including those in Asia — the dollar continued to strengthen against the euro during much of the year. This prompted the major central banks to undertake a coordinated intervention in September to slow the decline of the euro. In the fourth quarter, the dollar began to weaken, especially against the euro, as clear evidence appeared that the US economy was slowing.

Concerned about possible overheating, the authorities in the major industrial countries gradually tightened monetary policy during the early part of 2000. The Federal Reserve nudged up short-term interest rates in several steps in the US through midyear; the European Central Bank also raised policy interest rates in the euro area, as did the authorities in several other industrial economies. In the second half of the year, the Bank of Japan abandoned its long-standing zero interest rate policy and raised short-term rates slightly. Long-term interest rates remained generally low or declining in many industrial countries. To varying degrees, this reflected relatively strong actual and prospective budgetary positions and benign inflationary expectations.

Major equity markets remained at high levels in early 2000 with technology stocks, in particular, beginning the year with significant further advances. However, volatility in international financial markets began to increase later in the year as equity valuations, especially in the technology sector, collapsed and spreads on risky assets—including emerging market debt— increased. Within Asia, those DMCs that had benefited from the technology boom saw sharp further downward movements in their equity markets, in some cases reversing much of the gains made in 1999. The sizes of the corrections were also influenced in some countries by domestic political problems and uncertainties, and by concerns about the pace of domestic economic reform and financial restructuring. Worldwide, as the appetite for risk taking diminished, several developing countries experienced a weakening of their external capital account and downward pressure on exchange rates (see Figure 1.2). Although Argentina and Turkey had severe financial problems late in the year, the spillover to other countries was relatively limited, in part because of the prompt response of the international financial community.

Looking forward, the outlook is for more moderate growth in 2001 and 2002 compared with the first half of 2000 as the world economy moves to a more sustainable growth trajectory. ADO projections are that, following a cyclical slowing to around 3.5 percent in 2001, world growth will pick up to almost 4 per-cent in 2002, broadly in line with longer-term trends. As regards the major industrial countries, this strongly reflects a temporary sharp slowing of the US economy to a shade below 2 percent in 2001 followed by a recovery to around 3 percent in 2002. Although ADO forecasts are that growth in the euro area should be relatively well sustained, some moderation to 2.5–3.0 per-cent is expected in both 2001 and 2002, from 3.4 percent in 2000. After some weakness in early 2001, growth in Japan is expected to pick up modestly to 1–2 percent in 2002.

The near-term outlook for developing countries is mixed. The DMCs as a group are expected to experience one of the sharpest slowdowns as aggregate growth declines from over 7 percent in 2000 to 5.3 percent in 2001, before rebounding somewhat in 2002. This would, for the most part, reflect the effects of the slowing US economy and the moderation of the technology boom on many DMCs’ recent dynamic export per-formance. Even then, the DMCs would still constitute one of the fastest-growing regions in the world. Parts of Latin America are also expected to slow quite sharply in 2001, given close trade linkages with the US, but the region as a whole is expected to hold up quite well. Eastern Europe and Africa are expected to be less affected by the US slowdown, provided that growth is reasonably well maintained in the euro area.

The projected slowdown for the DMCs as a whole in 2001 masks variations across subregions. Among DMCs, those expected to see fairly sharp slowdowns are the newly industri-alized economies (NIEs) — namely Hong Kong, China; Korea; Singapore; and Taipei,China — and the countries of Southeast Asia depending heavily on technology exports and on the US market. Some of these economies began to slow in 2000 as their recoveries matured and the technology boom cooled. Con-versely, growth in the PRC and India is expected to hold up quite well, if domestic demand can be maintained. Growth in Cambodia, Lao People’s Democratic Republic (Lao PDR), and Viet Nam, as well as the Pacific DMCs is likely to be sustained or to strengthen in 2001–2002, on the assumption that the authorities persevere with crucial domestic reforms. Growth is expected to slow sharply in the Central Asian republics, reflecting pressures of a projected slowdown in the Russian Federation. Nevertheless, in many of these countries, the foundations are gradually being laid for sustained medium-term growth.

This relatively sanguine outlook for the global economy is subject to a number of near-term risks and uncertainties. Foremost among these is the risk of a deeper and more long-lived slowdown in the US and the uncertain outlook for Japan. In an environment of slowing global growth, the risks on the oil price front have receded as oil prices have fallen from their peak in 2000. In the absence of major supply disruptions, oil prices should not present a major risk.

Key short-term risks for DMC economies relate to the expected continued weakness of the US economy in the first part of 2001, development in the technology sector, and the prospects for the Japanese economy. The risks are especially significant for those DMCs where recoveries depend heavily on exports, where financial and corporate restructuring is incomplete, and where political uncertainties remain. The less favorable external environment will present challenges for these DMCs as they continue to implement structural reforms and seek to reestablish the conditions for strong and sustained medium-term growth.

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