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p. 4 of 81 BACK | NEXT I. Developing Asia and the World Developing Asia and the World Overview of 2001 Developing Asian Economic Trends External Conditions in 2001 and 2002 Subregional Trends and Prospects Medium-Term Outlook and Risks for Developing Asia II. Economic Trends and Prospects in Developing Asia III. Preferential Trade Agreements in Asia and the Pacific

Asian Development Outlook 2002 : I. Developing Asia and the World

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External Conditions in 2001 and 2002

Macroeconomic Conditions in Major Markets for Developing Asia’s Exports

The market for approximately one fourth of DMC exports — the US — is strengthening after a sharp mid-2000 deceleration that evolved into a mild recession by April 2001 and culminated in a GDP contraction in the third quarter of the year. With accelerating consumption and government expenditure growth more than offsetting double-digit contractions in private investment and exports, GDP growth reemerged in the fourth quarter of 2001 (Figure 1.2). Despite heightened uncertainty about economic prospects that characterized late 2001 and early 2002, the US economy returned to growth after only one quarter of economic contraction.

A key element of this rapid rebound from the shallow recession was the behavior of consumption. Contrary to the typical experience of past recessions, US consumption continued to grow—by 3.1% in 2001—despite contracting investment, falling financial wealth, rising consumer debt, declining employment, the events of September 11th, and the Enron collapse. Factors that could explain this remarkable resilience include (i) low inflation—especially declining energy prices and steep discounts for automobiles and other manufactured goods; (ii) macroeconomic stimulus—particularly interest rate cuts that, together with substantial gains in home equity, initiated a boom of refinancing and home sales that was a significant source of funds for home owners; (iii) sustained productivity growth —itself unusual for a recession; and (iv) general optimism about long-run economic prospects in light of perceived efficiency gains from improved ICT and increased flexibility in product and financial markets.

There were indications in early 2002 that the US economy was gathering momentum for a further strengthening in the first quarter of 2002. The wholesale inventories-to-sales ratio fell to 1.3 months in January 2002, its lowest level since March 2000. Manufacturing output began to grow again in February 2002 after 18 months of contraction.¹ Seasonally adjusted employment, which fell in 5 of the 6 previous months, rose by 0.6% in February 2002. However, US economic growth in 2002 is expected to be moderate relative to past recoveries because the mild character of the recession and persistent weakness in fixed investment reduce the scope for a strong rebound. Elsewhere in North America, Latin America, and the Caribbean, most economies with important economic ties to the US experienced relatively sharp slowdowns in 2001. Those economies with no significant cyclical or structural imbalances should rebound with the US.

The pace of 2001 economic growth in the euro area, which absorbs about 15% of DMC exports, slackened and turned into a contraction in the fourth quarter. This downturn resulted from weak consumption growth and continued contractions in investment and exports. For 2001 as a whole, economic growth was relatively balanced across demand components—private and government consumption each grew at just under 2% but the drag from declines in both fixed and inventory investment more than offset the positive contribution from net exports.

The euro area economy was showing evidence in early 2002 of growth momentum. The purchasing managers’ index for the euro area strengthened and business confidence rose for the second consecutive month in January. However, the seasonally adjusted rate of unemployment remained at 8.5% in December 2001, unchanged since September 2001. In addition, consumer confidence declined in January 2002. As a result, consumption growth is expected to be subdued in the early part of the year. Overall, euro area economic growth is expected to strengthen modestly in 2002 relative to 2001.

The United Kingdom expanded at a relatively strong 2.4% in 2001, as sustained consumption and government spending growth more than offset weak investment and export demand. This robust performance, especially in the context of a weak global economy, is expected to continue in 2002 because of ongoing strength in domestic demand and improvement in external conditions.

Japan, which is the destination for about 12% of DMC exports, slipped into an economic recession in the second quarter of 2001, shrinking for three consecutive quarters and posting negative growth for the year. This was because of a severe contraction in exports combined with falling public and private residential investment, which more than offset modest growth in business investment and government consumption, while private consumption stagnated.

In early 2002, the prospects for a Japanese recovery were rendered unclear by conflicting influences. Low business inventories and a strengthening US economy indicated an improving outlook. Further, although consumer confidence in January 2002 was below its level of a year earlier, it rose relative to December 2001, after 3 consecutive months of weakening. Business confidence was similarly weak, although improving, and the fiscal stance was still restrained. Overall, domestic demand is forecast to contract in 2002 with, perhaps, sufficient offsetting improvement in the external sector to bring about zero growth in 2002. However, private sector-led corporate mergers and acquisitions are increasingly restructuring the manufacturing and finance sectors, which should provide some scope for increased efficiency and productivity growth. This, together with sustained strength in external demand, should result in an improvement in the investment outlook, contributing to a return to growth in Japan in 2003.

In the US, despite the surge in energy prices early in 2001, average annual consumer price index (CPI) inflation fell to 2.9%, from an already relatively low 3.4% in 2000 (especially in the context of rapid growth and very low unemployment), while it edged up by 0.3 percentage points to 2.7% in the euro area. In Japan, deflationary conditions persisted as average prices fell by 0.7%, compared with a drop of 0.8% in 2000. Overall, subdued inflation in advanced economies was matched in developing economies under the influence of falling prices for most commodities and some manufactured goods.² Several factors are cited as having triggered the trend toward lower inflation in recent years, including increased global competition in key commodity and manufactured goods markets, and the growing number of countries adopting inflation rather than exchange rates as their monetary targets. The outlook is for global inflationary pressures to increase somewhat relative to 2001 but to remain relatively low in 2002–2003 by historical standards.

World Trade in Goods and Services

The US, euro area, and Japan together account for over 50% of DMC exports (when total DMC exports are adjusted for reexports from Hong Kong, China and Singapore). It was largely double-digit growth in imports by these three economies that fueled high rates of economic growth in many DMCs in 2000 and it was the rapid reversal of that trend that led to sharply slower growth rates in the same DMCs in 2001. Although the most extreme swing from strong growth to steep contraction occurred in the ICT sector, the trend was generally evident, though to a lesser extent, across most merchandise products. This is apparent in the trends for prices of merchandise exports (especially commodity prices—Figure 1.3).

According to International Monetary Fund (IMF) statistics, advanced economies’ import volumes of goods and services, which grew by an average 7.6% in 1995–1999, and reached 11.5% in 2000, are projected to have contracted by 0.3% in 2001. Because of the relatively modest nature of the economic recovery in the US, euro area, and Japan, and because the trade-dominating ICT sector will revive only slowly, trade is expected to rebuild to rapid growth only gradually. Single-digit growth is expected in advanced economies’ import volumes of goods and services in the first half of 2002, as domestic demand expansion will be somewhat subdued because of lingering excess capacity and profit weakness in manufacturing, which will limit investment growth. Thus, in general, DMCs may see slowly improving external demand, with growth of merchandise exports expected to be less than 6% in 2002, but conditions may vary by subregion and by sector.

The value of world trade in manufacturing exports, which accounts for 75% of the total value of world trade in merchandise exports, is expected to have contracted in 2001 after rapid growth in 2000.³ Of particular importance to DMCs are the ICT (specifically office machines and telecommunications equipment as defined in World Trade Organization [WTO] statistics) and the textile and clothing sector. ICT exports account for over 30% of DMC merchandise exports, and textile and clothing exports for over 8%.⁴ The ICT sector experienced a major boom-bust cycle that carried the economic performance of many DMCs up in 1999–2000 and down in 2001. An indicator of this sector’s health is the semiconductor chip market, which suffered a 31% decline in sales in 2001. Chip demand and the ICT sector as a whole are expected to recover relatively slowly in 2002, especially when compared with the rapid pace of expansion in 1999–2000. This is because retail sales of ICT products are expected to expand at a reasonable pace whereas corporate sales will be restrained by modest investment plans.

The growth of the value of world textile and clothing exports is expected to have slowed in 2001 from the 5% average pace of the previous decade as the rate of domestic demand growth slowed in major importing countries. Textile and clothing exports are expected to grow slowly in 2002 as world demand growth remains low relative to past trends.

Commodity exports are important to DMCs such as Indonesia, Viet Nam, and several economies in Central Asia. With falling demand, commodity prices fell in 2001, particularly in September 2001, reducing the value of such exports. The Futures Commodity Price Index of the Knight-Ridder Commodity Research Board fell by 16.3% during 2001, but this masks the beginning of a recovery late in the year. Commodity prices, which would generally be expected to continue to rebound with the pace of global economic activity, have experienced upward pressure.

Of particular importance, as a key barometer of energy market conditions and of business costs, the spot price of crude oil softened over the course of 2001. The spot price of Brent crude dropped by over 14% from end-December 2000 to end-December 2001 to under $20 a barrel, well below the Organization of Petroleum Exporting Countries’ (OPEC’s) target range of $22–$28 a barrel. This was despite announced OPEC production cuts totaling 5 million barrels or 20% of OPEC’s daily output during the course of 2001. However, oil prices began to climb in early March 2002 because of renewed concerns about the stability of supply in the Middle East and because of a stronger outlook for global recovery. By 15 March 2002, the Brent crude spot price was at $23.79 a barrel, up by 20% since the beginning of the year. Prices are expected to continue to firm in 2002 but to stay within OPEC’s target range.

The value of commercial services exports, about 20% of world exports of goods and services, grew by 6% in 2000 but is expected to have expanded at a slower pace in 2001, or perhaps even contracted. This is because of generally slowing economic activity throughout the year and disruptions to trade and travel from mid-September 2001. DMCs account for about 15% of the value of total commercial services exports. Of special importance to many DMCs is the tourism industry (Box 1.1). International tourist arrivals fell by 1.3% in 2001, compared with 7% growth in 2000, primarily because of a sharp worldwide drop in tourism in the last 4 months of the year. However, the outlook for the industry is considerably less bleak than predicted in late September 2001. While global travel is expected to remain subdued in the first half of 2002, it should recover in the second half of the year as expanding global economic activity increases business travel and aggressive marketing campaigns emphasizing enhanced security measures and lower prices begin to have a positive impact on leisure travel.

Box 1.1 Tourism Trends in Developing Asia Tourism is an important and—prior to September 11th 2001—rapidly growing industry, both in the world generally and developing Asia specifically.1 Indeed, because of its potential to provide foreign exchange earnings, fiscal revenues, services sector jobs, and backward linkages to industry, tourism is a prominent element of many DMC development strategies. The World Travel and Tourism Council (WTTC) estimates the total contribution of tourism in 2001 at over 10% of world GDP and nearly 8% of world employment (Box Table 1.1). Although tourism accounts for a slightly smaller share of GDP in developing Asia, nearly half of global tourism jobs are located in the region. Moreover, tourism grew at twice the world rate in developing Asia in 2000. Worldwide in 2001, it shrank as a result of the events of September 2001. In developing Asia, tourism growth fell significantly but remained positive. By subregion, WTTC statistics indicate that Southeast Asia and the Pacific DMCs have the tourism industries with the largest shares of GDP, but absolutely East Asia’s tourism industry is larger than that in the rest of developing Asia combined. The PRC is the fifth most visited tourism destination in the world with 31.2 million visitors in 2000.2 The PRC has the largest number of jobs provided by tourism in the world, at over 50 million, followed by India, at over 23 million jobs. In relative terms, however, the Maldives is the most tourism-dependent economy in the region (and third in the world), with about 51% of total employment in tourism. The Pacific DMCs are also relatively dependent on tourism. Tourism, being primarily service based, is typically less volatile than many other sectors. According to the World Tourism Organization, prior to 2001, international tourist arrivals had not declined worldwide since 1982. However, tourism is not immune to disruption. The September 11th attacks had an immediate and significant global impact on tourism. WTTC estimates that they caused a swing in tourism’s 2001 contribution to world GDP from projected growth of about 3% to a contraction of about 1%. In addition, WTTC projects that the attacks will result in an overall contraction of the global industry of about 0.4% in 2002. Although the largest absolute losses in tourism are being borne by the big markets such as the US and Europe, tourism in developing Asia is generally suffering more from the attacks in relative terms. This is in part because of perceived risk to the traveler, either from proximity to the fighting in Afghanistan or from internal security concerns. Destinations at a great distance from the traveler’s home also tend to be harder hit. WTTC reports that tourism in Southeast Asia, projected prior to the attacks to grow rapidly in 2001, contracted by about 1.8% instead. Thus, the attacks resulted in a loss of more than 6% of tourism contributions to GDP in 2001. An additional factor was the reduction in visits home by overseas workers who were suffering from reduced job security because of poor general global economic conditions. The Pacific DMCs experienced a deeper contraction in tourism while tourism growth slowed significantly in East Asia and South Asia. WTTC reports that the DMCs with the largest projected job losses in 2001 and 2002, in absolute terms, resulting from the attacks are the PRC (1.8 million or 3.4% of total tourism employment), India (0.9 million or 3.7%), Thailand (0.5 million or 14.1%), and the Philippines (0.3 million or 10.5%). In many DMCs, governments and the tourism industry have taken steps to mitigate weakness in the industry, including security measures to restore consumer confidence and increased marketing activity and promotional deals, particularly aimed at local or regional tourists. As a result of these activities, and of generally improving economic conditions, tourism is expected to begin recovering in the second half of 2002 and rebound strongly in 2003. Thereafter it is forecast to settle into robust long-run growth of 3.6%. Developing Asia as a whole—the PRC and India particularly—is expected to enjoy buoyant growth in tourism. However, for those DMCs with continuing internal security concerns, recovery of the industry could take longer. ________________ In this box, tourism is a set of direct and indirect economic activities associated with travel and tourism. The World Travel and Tourism Council (WTTC) refers to this measure, which captures the economic impact of tourism on GDP and employment, as the travel and tourism economy. The measure aggregates personal travel and tourism activities by residents and by international visitors, business travel, government travel and tourism expenditures, capital investment in travel and tourism, and exports of travel and tourism-related products. Source: WTTC, 2001, Tourism Satellite Accounting Research, available: www.wttc.org. World Tourism Organization, 2001, World Tourism Stalls in 2001, Press Release, 29 January, available: www.world-tourism.org. France, Spain, US, and Italy are the top four destinations, in that order.

Financial Markets

Global financial developments are of concern to DMCs both because international investors, banks, and corporations are sources of financial capital and because DMC financial market trends are heavily influenced by trends in major markets. Global financial markets in 2001 were characterized by weakness in equity markets, lower interest rates, steeper yield curves, and increased risk premiums for low-grade investments. They were also remarkably resilient: they suffered severe disruption in mid-September 2001, after which financial market turbulence dissipated rapidly. Moreover, while the global slowdown and the events of September 11th generally reduced portfolio flows to emerging markets, rising risk premiums on Argentina sovereign bonds in late 2001 did not lead to a global increase in sovereign risk spreads, as similar episodes had in the past.⁵

Worldwide equity markets were volatile in 2001 as sentiment about the expected duration of the economic downturn fluctuated between optimism and pessimism. Ultimately, markets worldwide lost value for the second year in a row, their worst performance since 1991, as the glowing corporate earnings outlook of the late 1990s faded amid a constant stream of announcements of downward earnings revisions. Morgan Stanley Capital International (MSCI) calculations show that most of the world’s major stock markets posted double-digit losses in 2001. As a result, the MSCI World Index fell by nearly 18% in 2001.⁶ Yet it is remarkable that, given severe post-September 11th disruptions (US stock markets closed for 4 days), losses were not more extensive. With substantial liquidity support from monetary authorities, coordinated efforts by market makers to avoid runaway sell-offs, and extensive corporate stock repurchases, stock markets in industrial countries (though not in emerging markets) returned to pre-attack levels by mid-October 2001. Because of evidence of improving conditions emerging in early 2002, most major stock markets had posted gains since the beginning of the year through 15 March 2002, and the MSCI World Index was up by 0.6%.

Bond market performance was a challenge to policymakers in 2001 as yield curves in major economies, such as the US, grew steeper during the year (Figure 1.4). In the first half of the year, US 90-day commercial paper rates fell by over 100 basis points but longer-term yields rose. This is attributable to the expectation throughout the first half of the year that a recovery would begin before the year was out. In contrast, the whole curve fell between end-June and end-October 2001. Despite further monetary easing, waning confidence in a quick recovery drove long-term rates down. However, in early 2002, the view that the period of monetary easing was nearing an end and the perception that the US fiscal budget would return to deficit, increasing the supply of government bonds, lifted the yield curve. Yield curve movements were more moderate in the euro area and barely perceptible in Japan because of less monetary easing.

Despite across-the-board declines in debt issuance, particularly in the second half of 2001, as corporate financing needs fell, credit spreads—generally falling in early 2001—began to rise in the third quarter for both lower-grade corporate issues and the sovereign debt of more vulnerable emerging markets. Whereas investment grade borrowers enjoyed more favorable rates, speculative grade issuers were increasingly confronted with higher spreads and more difficulty in placing issues. These tendencies, present in all markets, were more pronounced in emerging markets. Nevertheless, when yield spreads on Argentina’s sovereign debt began to rise sharply in late 2001, the effect on other emerging markets was limited (Figure 1.5). There are several factors that may account for this tendency for investors to focus on certain emerging markets, especially those with generally stronger fundamentals in some areas—including lower levels of short-term external debt, more flexible exchange rates, and, in many cases, current account surpluses.

The increased occurrence of current account surpluses in several economies, notably emerging markets in Asia, was accompanied, naturally enough, by capital outflows. Generally, the trend after the Asian financial crisis of weak private capital flows to emerging markets continued in 2001. January 2002 statistics from the Institute of International Finance indicate that, excluding Argentina and Turkey, net external financing to emerging markets fell slightly from $141 billion to $133 billion.⁷ In general, net private capital flows to emerging markets have been weak since 1998 at less than half the size experienced in the preceding 3 years. However, equity markets, particularly in East Asia and Southeast Asia, made some gains in the first quarter of 2002 as the global economic outlook improved. This trend should generally continue for all capital inflows (bank lending, portfolio flows, foreign direct investment) into emerging markets in Asia so that, overall, capital inflows into Asia are expected to increase in 2002 with the rebounding global economy.

The US dollar strengthened almost steadily throughout the first 6 months of 2001 against most major currencies (Figure 1.6). It began to soften in the third quarter, weighed down by evidence of a weakening economy, but recovered in the fourth quarter as investor flight to safe havens moved it higher against other major currencies. The US dollar ended the year slightly higher against the euro and significantly higher against the yen.

Macroeconomic Policy

As inflationary pressure dissipated and economic activity slowed rapidly in the US (and more gradually in the euro area over the course of 2001), monetary authorities took countercyclical action—aggressively so in the US. As the year wore on, and the global nature of the slowdown became more apparent, official interest rates fell worldwide. J.P. Morgan’s GDP-weighted average official interest rate fell by 230 basis points from end-December 2000 through 16 January 2002.⁸ In the US, the Federal Funds target rate was reduced by 475 basis points to 1.75% between end-December 2000 and end-December 2001. Although this had limited effect on investment, as plummeting profits and excess capacity led corporations to slash investment budgets, it lowered mortgage rates. The ensuing wave of refinancing bolstered household disposable incomes and provided support to consumption.

With clear indications of economic recovery, particularly in the US, and some evidence of inflationary pressure, particularly in the euro area, further easing in official interest rates is unlikely in 2002. However, with unemployment likely to remain relatively high, particularly in the European Union (EU), in most of 2002, large increases in official interest rates are not anticipated during the year but some tightening of monetary policies is possible, perhaps as early as mid-year.

Countercyclical fiscal policy measures were also undertaken in 2001, although less aggressively and less uniformly. Predominantly automatic stabilizers reduced the US government surplus from 1.5% of GDP in 2000 to 0.3% in 2001. Despite the limits of the EU’s Stability and Growth Pact, Germany’s fiscal balance went from a surplus of 1.2% of GDP in 2000 to a deficit of 2.5% in 2001. The United Kingdom reduced its surplus from 3.9% of GDP in 2000 to 0.5% in 2001. Canada and Italy also followed expansionary policies while, notably, France and Japan tightened their fiscal budgets. Under current policies, there will be considerable fiscal stimulus over the next 3 years, particularly in the US. The combined effects of a June 2001 tax cut package and an emergency spending authority enacted after September 11th, totaling $375 billion over fiscal 2002 (ending September 2002) to fiscal 2004, are projected to further reduce the US fiscal surplus in 2002.

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