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p. 5 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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Subregional Trends and Prospects

East Asia

East Asia, with a 58% weight in aggregate DMC economic activity, experienced a significantly slower pace of economic growth in 2001 than in the previous year (Figure 1.7). Growth moderated in the PRC, decelerated rapidly in Korea and Hong Kong, China, and reversed into recession in Taipei,China. Mongolia continued to struggle with low growth performance because of severe weather conditions and low commodity prices. The ability of the PRC, which carries a 26% weight in developing Asia’s aggregate GDP, to sustain a relatively high growth rate resulted primarily from strengthening consumption and, to a smaller degree, the momentum of optimism surrounding WTO accession. This drove foreign direct investment 15% higher than in 2000 to $46.8 billion, which, together with stronger domestic debt-financed public investment, lifted fixed investment by over 11% to nearly 39% of GDP in 2001 from 37% in 2000. In contrast, Korea and Taipei,China suffered fixed investment contractions of 1.7% and 18.2%, respectively, partly because of the global correction in the ICT sector. Taipei,China’s investment contraction was more severe because of a trend toward shifting production to the mainland in some industries. Hong Kong, China managed a 2.1% increase in fixed investment, based, in part, on an improvement in equipment purchases.

Diverse experience in domestic demand was similar to that in external demand. The growth in value of the PRC’s merchandise exports decelerated from 27.9% in 2000 to 6.8% in 2001. In 2001, the value of merchandise exports in Korea dropped by 14%; in Taipei,China by 17.3%; and in Hong Kong, China by 5.9%, reflecting the varying degrees of concentration of ICT products in their export mixes. Hong Kong, China suffered the further blow of a steep drop in demand for commercial port services as world trade activity, and particularly the PRC’s, slumped.

Finance sector performance also showed a divergence in 2001 among the East Asian economies. Korea’s stock market performance was among the best in the world, with the Korean Stock Price Index surging by 32% in US dollar terms. In part, this was a consequence of the perceived long-run strength of the economy. The PRC’s Shanghai B Index gained 91% on the year. However, this combined rapid gains immediately after the Index opened to domestic investors in February 2001 with a 21% loss in the second half of the year as enthusiasm waned because of poor corporate performance, increased regulatory oversight, and a controversial proposal to sell government shares in state-owned enterprises (SOEs), which would substantially increase the supply of equities in the market. Because of sharply decelerating growth and uncertainty about future prospects, Hong Kong, China’s Hang Seng Index lost 25% of its value in 2001. Taipei,China’s Taiwan Stock Exchange index, which had fallen by about 27% in US dollar terms through the third quarter of 2001, bounced back in the fourth quarter to improve by over 11% during the year.

With the pace of economic activity ebbing, inflation, at 1.4%, was slightly higher in East Asia in 2001 than in 2000, but still very low. Labor market conditions generally deteriorated in the subregion. Unemployment reached a record 5.3% in Taipei,China. In Korea, however, the unemployment rate fell over the course of 2001 as strong domestic demand propelled job creation in the services sector, particularly venture capital, more than offsetting job cuts in manufacturing, which registered a fall in employment during the year. In Hong Kong, China, the unemployment rate rose from 4.4% in 2000 to 6.1% in 2001. This was nearly as high as the record level experienced in 1999, when the economy grew slowly as it struggled to recover from a sharp, financial crisis-related contraction in 1998. Uniquely among DMCs, Hong Kong, China recorded price deflation in 2001, for the third year in a row, as property prices continued to decline and retailers offered large discounts to reduce inventories.

Under these conditions of low inflation and rising unemployment, there was mixed macroeconomic policy in East Asia. The PRC sustained a policy of deficit spending, but the deficit fell as revenues increased by more than public expenditures. With spending below target, Korea expanded the fiscal surplus from 1.1% in 2000 to 1.3% in 2001, despite tax cuts and a supplementary spending package in the third quarter. Hong Kong, China’s fiscal deficit ballooned from less than 1% of GDP in 2000 to over 5% in 2001 as rapidly decelerating economic activity eroded revenues while expenditures rose by over 10%. Taipei,China marginally reduced its fiscal deficit in 2001 with a combination of higher revenues and increased spending.

In general, the economies of East Asia do not have large public debt burdens, as compared with Latin America and the Caribbean, or South Asia. However, there has been an increasing trend toward deficit spending in the last several years that is pushing up public debt. In the PRC, for example, government debt increased from about 10% of GDP in the mid-1990s to about 23% in 2001.

Monetary policy was accommodative in 2001 in Korea and Taipei,China, which made official interest rate cuts of 125 basis points and 250 basis points, respectively. But this had limited impact on credit expansion through much of the year, although retail lending began to pick up in the fourth quarter in Korea. Both economies experienced relatively mild exchange rate depreciation. In the PRC, interest rates on US dollar deposits were cut more or less in line with US official target cuts, leaving them lower than local currency deposit rates at the end of 2001. Similarly, Hong Kong, China lowered interest rates in parallel with the US cuts. The PRC maintained its de facto exchange rate peg to the US dollar and Hong Kong, China maintained its currency board arrangement.

In terms of structural changes, the PRC and Taipei,China joined WTO, thereby committing to a wide range of reforms—key among them being in the finance sector. The benefits of these reforms will be felt over the medium to long term. In Korea, corporate and finance sector reform, which is still key to the medium- to long-run outlook, slowed in 2001 as political opposition mounted while Hong Kong, China tempo- rarily suspended its Home Ownership Scheme (through mid-2002), under which low-income families can obtain subsidized housing, to allow conditions in the property market to improve. The major challenge for Hong Kong, China over the medium to long term is comprehensive tax reform to rectify persistent fiscal deficits.

Over the next 2 years, economic performance is expected to strengthen in East Asia, with GDP growth rising to over 5% in 2002 and to over 6% in 2003. In part, this will come about because of an improvement in the external environment. The value of merchandise exports, which contracted in 2001, will grow moderately in 2002 before rebounding to nearly 9% growth in 2003. This should allow the PRC to boost growth modestly in 2003 after some slowing in 2002 as it begins to adjust to WTO membership. Korea should rebound moderately in 2002 as the US recovers, with further strengthening in 2003 as its other important market—Japan—strengthens. Economic growth in Hong Kong, China will improve but it will be limited by continued weakness in domestic markets—particularly real estate. Taipei,China will revive moderately from recession as a weak global recovery, uncertain investor and consumer confidence, and the structural challenge of WTO membership combine to limit a rebound. Mongolia, while still suffering from the devastating effects of severe winter weather on agriculture, should benefit from a recovery in commodity demand. In aggregate, growth in East Asia, while improving over the next 2 years, is likely to be below historical trends.

Southeast Asia

With nine members of the Association of Southeast Asian Nations (except Brunei), this grouping of countries, representing just under a quarter of DMC economic activity, slowed from nearly 6% growth in 2000 to below 2% growth in 2001 (Figure 1.8). However, there was a marked contrast between the performance of Singapore and four former crisis countries of Indonesia, Malaysia, Philippines, and Thailand on the one hand, and of the Mekong countries of Cambodia, Lao People’s Democratic Republic (Lao PDR), and Viet Nam on the other. The former group generally suffered more severely from exposure to the global economy.

Heavily dependent on ICT trade, Singapore’s economy, after booming by 10.3% in 2000, contracted by 2.0% in 2001 as the value of merchandise exports shrank by 11.9%. Malaysia’s economy, similarly ICT trade-dependent but with a smaller drop in domestic demand, decelerated from over 8% growth in 2000 to less than 1% in 2001. In Thailand, with a somewhat smaller export contraction, economic growth slowed from 4.6% in 2000 to 1.8% in 2001. In contrast, the Philippines, which suffered a 16.2% decline in exports, experienced only a modest slowdown in economic growth because of stronger domestic demand. With a relatively diversified export base, Indonesia’s 2001 economic performance lagged behind only that of the Philippines in this group, because of less strength in domestic demand.

In contrast, Cambodia, Lao PDR, and Viet Nam all sustained growth rates of over 5% in 2001 with merchandise export value growth rates of 6–8%. This is, in part, because these economies have preferential (Cambodia) or improved (Viet Nam) access to markets in industrial economies, allowing strong growth of textile and clothing exports. Additionally, Viet Nam benefited from robust expansion in fisheries exports. Moreover, the agriculture sector, which is still large in these economies relative to the crisis countries, had a reasonably good 2001 in Cambodia and the Lao PDR. Viet Nam had healthy investment growth because of investor optimism generated by a bilateral trade agreement signed with the US in 2000.

The relatively slow growth rates in 2001 meant further delays in meaningful improvement of the welfare of the poor—particularly in Indonesia and Thailand, where the severity of the economic contractions associated with the crisis partially eroded past progress in reducing poverty—but also in the Philippines. In Cambodia, Lao PDR, and Viet Nam, steady growth performance and job-creating expansion of export manufacturing sectors in 2001 allowed poverty reduction progress to be sustained.

The direction of macroeconomic policy performance in 2001 was mixed in Southeast Asia, with Malaysia and Singapore adopting aggressive stimulus measures similar to those of the East Asian economies while other governments pursued less active countercyclical policies, in part because of limited capacity to do so. Malaysia expanded the fiscal deficit, relative to GDP, with supplementary spending. Singapore engaged in substantial off-budget fiscal stimulus in the face of rapidly slowing economic conditions. Indonesia’s wider deficit arose from debt service and project-funding requirements. This wider deficit was thus planned, and Indonesia met its deficit target under an IMF agreement. The fiscal deficit in the Philippines contracted mildly to below 4% of GNP in 2001, an important accomplishment following the deterioration of fiscal performance in the latter part of the previous year. Thailand’s deficit also fell by a full percentage point to 2.1% of GDP because of lower capital spending. In Cambodia and the Lao PDR, the size of fiscal deficits relative to GDP, which are mostly financed by official development assistance, were broadly stable in 2001. In Viet Nam, the deficit grew.

Monetary policy across the subregion was mixed as monetary authorities, with varying tools, straddled competing objectives. In the Philippines, interest rates have been lowered by more than 750 basis points since December 2000, at which time they were at high levels, having been raised to prevent capital flight. In contrast, Indonesia and Thailand have followed relatively tight monetary policies. In Indonesia, with inflation remaining in double digits, the exchange rate still weak, and the need to attract financing for public debt, interest rates have remained high. In Thailand, official interest rates were raised in mid-2001 because of concern about a weakening baht and capital outflows. This tightening of Thai monetary policy was partly reversed in early 2002 as the baht strengthened.

In the three Mekong countries, in which the dollar circulates widely and the banking sector is underdeveloped, money supply expansion supported financial deepening and exchange rate depreciation was mild. In Malaysia, which pegs the ringgit to the US dollar, the central bank made only one official interest rate cut, of 50 basis points in late September 2001. In Singapore, which does not directly influence interest rates but maintains an exchange rate band, this band was widened to allow the Singapore dollar more flexibility to adjust to external conditions.

The outlook for Southeast Asia is for gradual strengthening of economic growth that will, nevertheless, stay below past performance over the medium term. This is because, for Indonesia, the Philippines, and Thailand, external demand will only slowly recover and because domestic demand will remain weak over the medium term. To varying degrees, high levels of public debt, incomplete corporate and finance sector restructuring, investor caution, and weak political will to reform hamper each of these countries. Thus, each is expected to continue to make only very limited progress in reducing poverty. In contrast, Cambodia, Lao PDR, and Viet Nam are expected to continue to improve both economic performance and capacity to significantly reduce poverty over the medium term.

South Asia

South Asia accounts for about 17% of the DMCs’ GDP, of which India represents 76% (Figure 1.9).⁹ In India, with fiscal year 2001 closing at end-March 2002, substantially improved agricultural performance is projected to offset slowing industrial growth. Bangladesh, Nepal, and Pakistan, for which the fiscal year ended in mid-2001, experienced moderately slowing economic growth, primarily because of slowing agricultural growth in Bangladesh and Nepal—after bumper crops in the previous year—and because of a drought-related agricultural contraction in Pakistan. In the first half of fiscal year 2002 (the second half of calendar year 2001), these countries experienced further weakening in the pace of economic activity, in part because of slowing external demand and the disruptions of military operations in Afghanistan. For the economies reporting on a calendar year basis, Bhutan maintained strong economic growth based on expansion of the hydropower sector; performance in the Maldives deteriorated because of a severe drop in tourism in the fourth quarter; and Sri Lanka experienced a contraction because of slowing external demand and drought, exacerbated by security problems.

Although not so heavily dependent on the ICT sector, the subregion experienced a drop in merchandise exports that was nearly as severe as in East Asia and Southeast Asia. India is expected to experience a contraction in merchandise exports in fiscal year 2001, in part because of a drop in demand for its computer and ICT-related services. In Bangladesh and Pakistan, export growth in 2001 strengthened relative to 2000. During 2001, exports of textiles and garments were relatively robust, benefiting in part from strong US consumption growth. However, in the first part of 2002, exports weakened. Nepal’s exports growth settled back close to 4% in 2001 from extremely fast growth because of rapid expansion of carpet and garment exports in 2000. Sri Lanka suffered a sharp reversal in export performance, from double-digit growth to double-digit contraction, because of deterioration in external markets and internal disruptions, which raised shipping costs. In addition to weakness in merchandise exports, tourism suffered in South Asia. International tourist arrivals to the subregion are estimated by the World Tourism Organization to have fallen by over 6% in calendar year 2001 with the Maldives, Nepal, and Sri Lanka, where tourism is relatively more important, the hardest hit.

With rapid labor force growth in South Asia of 2% a year and significant underemployment or disguised unemployment, GDP growth of less than 5% for the subregion is probably insufficient to generate adequate job and wage growth for meaningful poverty reduction. Although strong agricultural performance in Bangladesh and India likely helped the rural poor subsist, weak industrial growth did not generate the higher incomes and lower-risk employment that can provide more secure graduation from poverty.

Fiscal policy was variable. India’s fiscal deficit remained flat despite a combination of contracting imports, and hence low import-based revenues, and increased defense spending. Pakistan cut its fiscal deficit by more than 1 percentage point of GDP to 5.3% under an IMF standby arrangement, although this was accomplished primarily through expenditure cuts. Bangladesh had small reductions in the fiscal deficit as a proportion of GDP. Despite this progress, South Asia continues to be characterized by relatively high fiscal deficits and large government debt burdens. Yet, particularly in India, much of this debt is domestic debt, which means that it is much less vulnerable to external shock. However, it tends to crowd out more domestic private investment.

Against a backdrop of generally low or falling inflation, monetary policy in South Asia was moderately accommodative—India reduced the official bank rate from 7.0% to 6.5%, Pakistan from 12.0% to 9.0%—but with limited impact because of conditions of excess liquidity. Both Pakistan and Sri Lanka moved to more liberal exchange rate regimes. Pakistan moved from a managed float to a free float exchange rate system at the start of the fiscal year. Sri Lanka moved from a fixed rate to a float in January 2001 as reserves dwindled, and the currency depreciated. Bhutan and Nepal retained exchange rate pegs to the Indian rupee.

Perhaps the key constraint on development in the subregion is that structural reforms are either slowing or stagnant. In India, a combination of factors, including a relative lack of interest on the part of potential foreign buyers, complicates the related issue of privatization. Pakistan is having similar trouble finding buyers for some of its SOEs, given the current economic climate. In Bangladesh, the new Government intends to broaden market-friendly reforms, but concrete progress has yet to be made. Nepal’s efforts to reform its troubled banking sector are moving ahead slowly, adjust a backdrop of political and economic turbulence.

The outlook for South Asia is for further strengthening of growth over the medium term. In part, this is a result of an improvement in external demand both because of a generally improving global economy and because of more stability in the subregion. Merchandise export growth should accelerate significantly. Tourist arrivals should rebound somewhat in the second half of calendar year 2002, although the subregion’s tourism industry is expected to recover only slowly from the impact of September 11th and its aftermath. A general improvement in domestic demand is also forecast for the subregion. Based on the improvements in global economic conditions, internal security, and political stability, investment growth should improve. In Afghanistan and Pakistan, substantial inflows of official development assistance should support increases in public investment.

Central Asia

Central Asia, benefiting from strong commodity demand in late 2000 and early 2001, and from rising investment in oil and minerals, enjoyed rapid growth in 2000. Growth further accelerated in 2001 despite slowing commodity demand and collapsing commodity prices in the fourth quarter of 2001 (Figure 1.10). In Azerbaijan, Kazakhstan, and Turkmenistan, where oil and gas accounted for over 80%, over 50%, and over 60%, respectively, of the value of exports in 2000, the volume of oil and gas exports continued to rise in 2001. Further, investment in the development of oil and gas fields continued to expand. In the Kyrgyz Republic, where gold mining dominates industrial activity, economic growth was sustained in 2001 largely by increased volume of gold production and strong agricultural growth, particularly grain production. In Tajikistan, aluminum, accounting for 50% of the value of exports, sustained industrial growth in 2001, which together with very strong agricultural performance, primarily in cotton, boosted economic growth that year. The performance of Uzbekistan, with the largest population among the Central Asian republics (CARs), has lagged behind that of the other CARs because of structural problems and weak exports.

Large structural distortions, off-budget spending, and inaccurate statistics make it difficult to interpret or compare developments in macroeconomic policies in the CARs. Nevertheless, some common features are apparent. Many CARs are dependent on taxes from commodity exports for revenues but otherwise have weak tax administration. Azerbaijan and Kazakhstan have set up national funds with oil sector receipts that can help cushion the budget in lean times. Both appear to have allowed fiscal deficits to widen somewhat in 2001, with increased expenditures on state payrolls in Azerbaijan and on defense in Kazakhstan. The Kyrgyz Republic recorded a slight increase in revenues as a proportion of GDP in 2001 because revenue collection efforts were enhanced by stronger tax measures. Uzbekistan, with low revenues and extensive off-budget subsidies to SOEs and favored sectors under import-substitution schemes, financed the deficit through borrowing from the central bank.

Rapid recent economic growth, fueled by commodity sector development, belies fundamental structural problems still confronting the CARs, including fixed exchange rates with active parallel exchange markets or multiple exchange rate systems, relatively high levels of inflation—particularly in Tajikistan and Uzbekistan—and continued high levels of state involvement in the economy. In addition, many CARs have yet to make significant progress in improving the climate for foreign investment.

The outlook for the CARs is for economic growth to moderate somewhat from the rapid pace set in 2000 and 2001. Nevertheless, growth will still be in the double digits in Azerbaijan and Turkmenistan, and 6–8% in Kazakhstan and Tajikistan, as they continue to rebuild their economies on the basis of continued expansion of their export sectors. However, the Kyrgyz Republic and Uzbekistan will likely experience slower growth than other CARs over the next 2 years, reflecting weak export markets. Sustaining or improving performance in the subregion will depend primarily on structural reforms that address the weaknesses discussed immediately above and that allow diversification away from overdependence on commodity exports.

Pacific Developing Member Countries

The economies of the Pacific manifested a mixed performance in 2001 (Figure 1.11). Papua New Guinea underwent a second year of economic contraction, in part because of a strong decline in mining and in part because commodity exports fell with weakening world demand. The Fiji Islands recovered from a political crisis-induced contraction of economic activity in 2000 to record growth of about 1.5% because of rebounding tourism. Samoa and East Timor (the latter is not included in subregional averages) experienced double-digit growth, the former because of reforms introduced in the 1990s, and the latter as conditions normalized and the country began to recover from substantial deterioration in 1999. The economies of Solomon Islands and Vanuatu both contracted, the former for the third straight year as a consequence of ethnic unrest and the latter because of cyclone damage to agricultural production. The Cook Islands sustained moderate growth based on strength in tourism while Tuvalu did so with higher public spending. While Kiribati emerged from recession based on expansionary fiscal policies, the Marshall Islands and Federated States of Micronesia (FSM) struggled, with growth of less than 1%.

A common theme among the Pacific DMCs is difficulty in fiscal management because of the small size of the economies, exposure to external shocks, inexperienced civil services, dependence on external funding, and frequent episodes of political instability. In Papua New Guinea, with tax revenues declining in the face of a weakening economy, the Government was forced to shave expenditures because of a delay in accessing external funding that was contingent on the privatization of a public sector bank. The Fiji Islands ran a fiscal deficit of 4.9% of GDP, financed by an increase in Government debt to 43% of GDP, excluding contingent liabilities. Kiribati was able to draw on resources available through its Revenue Equalization Reserve Fund to replace a shortfall in revenues while Nauru has virtually depleted a similar fund, built on revenues from now depleted phosphate mines. FSM and the Marshall Islands each relies on US transfers under a Compact of Free Association, extensions to which are currently under negotiation. The Cook Islands made progress in reducing its large public debt through improved revenue mobilization. Solomon Islands and Tonga have deteriorating fiscal positions, leading to high debt and balance-of-payments pressure in both countries.

The Pacific DMCs are forecast to return to growth in 2002, with further strengthening in 2003, as Papua New Guinea emerges from recession into low growth because of a combination of modest improvements in agriculture and structural changes in the economy. Economic growth is expected to strengthen in the Fiji Islands, with generally broad-based growth led by improvements in tourism. In general, prospects for economic growth in the Pacific DMCs are clouded by a host of structural problems, including factor market rigidities, depletion of natural resources, the continued potential for civil unrest, and the domination of economic activity by the public sector.

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