Catalog

	Table of Contents
p. 6 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

---

Medium-Term Outlook and Risks for Developing Asia

Growth in developing Asia is expected to strengthen moderately in 2002, picking up further in 2003, as the region slowly returns to a more balanced and sustainable pace of development after a turbulent 1997–2001 period. Overall, aggregate growth for major DMCs will stay well below its trend in the 1980s but draw within reach of its long-run (1951–2000) trend (Table 1.3). The major DMCs of South Asia are expected to sustain the growth performance achieved in the 1980s and 1990s, which was well above the long-run trend. The major DMCs of East Asia and Southeast Asia are projected to achieve growth performance over the medium term that is below long-run trend growth and well below growth performance over the 1980s. A critical question for these DMCs is whether, and how soon, they can return to the rates of growth approaching that long-run trend. Over the next few years, the answer rests, in part, on the strength of external demand. Ultimately, however, DMC growth performance will depend on domestic conditions. For those countries most affected by the financial crisis, weak financial and corporate fundamentals caused by high levels of nonperforming loans will inhibit long-run growth (Box 1.2).

Box 1.2 Nonperforming Loans—A Lingering Issue The ability of developing member country (DMC) governments to effectively use accommodative monetary policy to counter the economic slowdown in 2001 was partly determined by the strength of the finance sector. This was especially true for those economies most affected by the Asian financial crisis, which resulted in high levels of nonperforming loans (NPLs), or in loans on which payments have not been made for an extended period of time. Many DMC governments undertook at least some official interest rate cuts during 2001 (although not Indonesia or Thailand, which both followed restrictive monetary policies). Yet the effectiveness of these policy moves to stimulate economic activity was hampered in some DMCs because the cuts did not trigger credit expansion due to a combination of supply and demand conditions. On the demand side, relatively strong corporations tended not to take advantage of readily available bank credit—either because they preferred to issue bonds at favorable rates or because they trimmed their investment plans. On the supply side, financial institutions were hesitant to lend to weaker firms, which increasingly faced worsening business conditions and liquidity shortages. The finance sector, hobbled by the lingering effects of the Asian financial crisis, was unable or unwilling to assume the associated risks. Nearly 5 years after the start of the financial crisis, the five most crisis-affected economies show uneven progress in resolving the problem of high levels of NPLs in the finance sector (Box Table 1.2). Of the five countries, all except the Philippines adopted mechanisms for reducing the level of NPLs through the formation of asset management companies (AMCs) to buy distressed loans from financial institutions with public or publicly guaranteed funds. This was done to quickly restore the financial institutions to health so that they could focus on new lending to assist in bringing the economies out of crisis. By October 2001, AMCs in the four other crisis countries had purchased significant portions of NPLs, particularly in Indonesia, and the direct burden on the finance sector of NPLs had fallen. In the Philippines, which initially had a less serious problem, NPLs have been climbing as a result of economic weakness due to the financial crisis, political turmoil, and the global slowdown. However, particularly for Indonesia and Thailand, which initially had the largest ratios of NPLs, the effectiveness of the AMCs in restoring financial and corporate sector health has been inhibited by slow disposal of assets. Indonesia has been the slowest to dispose of AMC-held NPLs. Plagued by accusations of corruption and political opposition to the sale of distressed companies to foreign entities, the Indonesian Bank Restructuring Agency, formed in early 1998, had disposed of less than 7% of its NPL assets by the end of 2001. Thailand has also struggled to accelerate resolution of its finance sector problems. The Thai Asset Management Company (TAMC) was set up only in mid-2001, after resolution of NPLs through judicial and administrative workouts proved inefficient. In early January, it reported that it had disposed of about $1 billion of $16 billion (or about 6.3%) in NPL assets, which were primarily acquired from state-owned banks. The private sector remains concerned about some legal and political aspects of TAMC operations, such as the level of transparency of debt resolution and the financial obligations of private sector participants in the process. The overhang of NPLs held by the AMCs is one factor retarding economic recovery by delaying corporate restructuring. Thus, corporate sectors are clogged with inefficient companies (often state owned), with high debt, low profit, and little capacity to invest. Continued finance sector weakness, together with other structural problems, is resulting in relatively weak capital inflows and low levels of investment in Indonesia and Thailand relative to pre-1997 levels. These problems include slow progress in privatization and ineffective legal systems that leave foreign entities uncertain of the extent of legal protection they can expect. Both countries have been characterized by sluggish investment and economic growth compared with their pre-1997 averages.

Externally, the projections for 2002–2003 are contingent upon a sustained improvement in the global environment, although DMC export growth rates are not expected to return to the rate of over 20% seen in 2000. The US recovery that began in the fourth quarter of 2001 is expected to continue to build, although slowly by the standards of past recoveries. It should be accompanied by an improvement in economic conditions in the EU and Japan.

Other external conditions key to a sustained and robust revival of economic expansion in developing Asia include relatively low and stable oil prices and interest rates throughout 2002. Further, it is assumed that the major currencies will experience no major realignments in 2002. Moreover, a continuing trend of generally falling bond spreads in developing Asia will be important. Under these conditions, a gradual recovery in global trade and a moderate improvement in capital flows to DMCs should provide favorable conditions for economic growth to all the subregions of developing Asia.

Increased uncertainty over economic conditions has complicated the task of forecasting in recent years.¹⁰ Thus, a careful assessment of risk factors is critical to an understanding of the complete picture of possible economic performance in developing Asia.

The major short- to medium-term external risks to the moderate recovery forecast for the region are that (i) export demand will be weaker than anticipated and (ii) disruptive global events or temporary bottlenecks will cause inflationary pressure for key commodities—particularly oil. The primary medium- to long-term internal risk to the ability of a large number of DMCs to generate high rates of sustained economic growth is that slow progress in structural reform will inhibit domestic demand expansion and productivity growth.

External Risks

A major risk that could result in slower regionwide economic growth in 2002–2003 than expected in the Asian Development Outlook 2002 forecast is that the recovery in external demand proceeds at a slower pace than anticipated. This could occur for two reasons. First, the global trend of strengthening economic activity and trade could be slowed by prolonged weakness in investment. Second, a current account correction or increased transactions costs on international trade could reduce the US propensity to import goods for a given level of aggregate demand. Consequences for the Asia and Pacific region include (i) continued weakness in export markets, (ii) further erosion of corporate and finance sector health resulting from a prolonged period of weak earnings, and (iii) high unemployment or underemployment with continued fiscal constraint, implying slowing progress in poverty reduction.

A possible source of a faltering global rebound is the inability of the US economy to sustain its emerging recovery because consumption growth might slow or exports might stay sluggish (or both). This would likely result in generally weak earnings projections, which in turn, would prevent a recovery of investment demand. Thus, as the positive influence on growth from a fading inventory correction dissipates, momentum would falter. However, as evidence of economic strengthening continued to mount in late March 2002, this risk appeared to recede.

An adjustment to the US current account balance is of increasing concern because of the sheer magnitude of the deficit in recent years. After averaging zero in the 1970s, 1.7% of GDP in the 1980s, and 1.6% of GDP in 1994–1997, the current account deficit rose rapidly over 1998–2000, reaching 4.4% of GDP in 2000 as the gap between economic performance in the US and other economies widened.¹¹

There is a fair possibility that, with the US poised to emerge from the global economic slowdown ahead of both the EU and Japan, the US current account deficit will widen further before it begins to shrink, increasing the chance of a sharp adjustment being precipitated by an event (or series of events) that erodes the global appetite for US financial assets. The fallout from the Enron debacle dampened US stock market performance in January and February in 2002 as the financial accounting of other corporations came under scrutiny.

However, the risk that the Enron contagion would spread across the corporate US seemed to have disappeared by March. The Government, accounting industry, and corporations in the US moved quickly to enact reforms and restore confidence, with some success as US equity markets moved into positive territory for the year in late February. Moreover, the trend toward tightening of accounting standards spread to Europe and Asia. Increasingly, institutional investors are putting pressure on countries and individual firms to improve financial reporting. An example is the announcement in late February 2002 that the largest US pension fund—California Public Employees’ Retirement System—enacted new investment guidelines that include transparency, leading it to pull out of investments in several markets in developing Asia.

Although a current account correction would likely be gradual, it would tend to reduce the US propensity to import. A second factor that might reinforce this tendency is an increase in international trade costs associated with heightened security concerns at national borders and points of entry. This may, over the medium term, affect the optimum level of cross-border outsourcing by manufacturers.

A significant risk to the recovery that was of increasing concern in late March 2002, involves a reemergence of inflation. There are two possible sources. First, disruptive events in the Middle East could cause skittish oil markets to send prices higher. The price of Brent crude oil shot up by over 15% in about a week to $22.85 by 7 March 2002. If prices continue to rise, major oil importers such as Korea could be adversely affected by rising inflation and shrinking current account surpluses.

Second, the lagged effects of large doses of macroeconomic stimulus—combined with aggressive inventory corrections and massive layoffs—could create conditions of rapid demand growth in which bottlenecks occur, fueling inflationary conditions that lead to premature tightening by monetary authorities.

Domestic Risks

Because the outlook for external demand recovery remains relatively moderate, achieving and sustaining higher rates of poverty-reducing economic growth over the medium term rests, more than ever, on the strength and character of domestic demand expansion. DMCs, particularly those in East Asia and Southeast Asia (which have historically encouraged high savings rates and favored investment in export industries) are increasingly recognizing the critical contribution that a vibrant domestic market can make to a stable and balanced growth path in which all of the major sectors of the economy experience dynamic progress.

Thus, a significant risk on the domestic front for many DMCs is that they may fail to take the opportunity to use stronger growth performance over the next 2 years to move aggressively on structural reform. Renewed focus on domestic demand policies, including progress on corporate and financial restructuring, as well as competition policy and labor market reform, could provide the impetus for continued high rates of long-run growth. With slow progress on reform, DMCs risk a prolonged period of low growth because of increased global competition in traditional export markets and the likelihood of reduced import growth in industrial countries over the medium term.

________________

Back Subregional Trends and Prospects	Next II. Economic Trends and Prospects in Developing Asia