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p. 5 of 68 BACK | NEXT I. Developing Asia and the World Overview of Economic Trends and Prospects Overview of Economic Trends in Developing Asia in 2002 Macroeconomic Conditions in 2002 Outlook for Industrial Countries Developing Asia: Subregional Trends and Prospects Developing Asia: Risks and Uncertainties Overview of Fiscal Policy in Developing Asia II. Economic Trends and Prospects in Developing Asia III. Competitiveness in Developing Asia Statistical Appendix

Asian Development Outlook 2003 : I. Developing Asia and the World : Overview of Economic Trends and Prospects

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Outlook for Industrial Countries

The growth momentum of the world economy was clearly slowing in the closing months of 2002 and growth is likely to remain subdued during the first half of 2003, and possibly into the third quarter. Nevertheless, barring major catastrophes affecting the world economy, a modest upturn is likely to start in the second half of the year in response to additional policy stimulus in industrial countries, particularly in the US, euro area, and Japan (Table 1.2). Consumption demand has played an important role in the past few years in supporting economic growth in industrial countries, particularly in the US. With the possible exception of the euro area, consumer demand is, however, likely to be weaker during most of 2003 than it was in 2002. The upturn projected in the latter part of 2003 in industrial countries critically relies on an improvement in business investment, which should start contributing positively to growth after 2 years of a negative contribution. The upturn in industrial countries is projected to further strengthen in 2004 as uncertainties in the world economy abate. Hence, GDP growth for industrial countries is forecast at 1.5-1.7% in 2003 and 2.7-2.9% in 2004. This compares with an outcome of 1.4% in 2002.

Baseline Assumptions on External Conditions

Many economic indicators in the US (car, home, and retail sales; business investment on equipment and software; job creation) weakened in the fourth quarter of 2002 and GDP growth dipped to an annual rate of 1.4%. Slow growth is likely to continue at least for the first half of 2003. Prospects for the US economy continue to be affected by the hangover of the investment bubble of the past decade, the estimated $6 trillion decline in household net worth (since early 2000), and concerns about continued increasing unemployment rates. Other uncertainties relate to a possible retrenchment in the housing market and negative wealth effect, the impact of uncertainty related to the conflict in Iraq and its aftermath, and the prospects of a sharply deteriorating fiscal situation over the medium term.

In March 2003, the Conference Board's Consumer Confidence Index reached its lowest level in nearly a decade. On the positive side, however, corporate profitability appears to be improving as a result of restructuring efforts, substantial improvements in productivity, and tax cuts, thus eventually leading to an anticipated revival in corporate investment. The improvement in corporate balance sheets over the past year has resulted in a reduction in interest rate spreads and the cost of capital for corporate borrowing. Already there are some signs of this improvement business investment picked up in the fourth quarter of 2002 for the first time in 2 years. A positive factor is productivity growth, which should result in increasing real wages and provide some support for growth in consumption spending in 2003. Hence, a progressive improvement in business investment offsetting somewhat weaker consumption demand is a key element in the improving US outlook in the second half of 2003 and in 2004. The November Federal Funds rate cut of 50 basis points to 1.25% should add to the impact of the cumulative cuts of the past years, further supporting spending and investment. In the baseline scenario, the Federal Funds rate in 2003 is projected somewhat below the 2002 average before rising in 2004 as inflation picks up a little and as the fiscal deficit deteriorates further. US fiscal policy will be expansionary in 2003-2004 as tax cuts are implemented. Finally, a weaker exchange rate for the dollar might provide some stimulus for exports. Generally, US growth in 2003 should be more evenly balanced between consumption and investment growth as nonresidential investment begins to improve after 2 years of decline while private consumption and residential investment moderate somewhat. The baseline growth forecast for the US economy in 2003 is 2.2-2.4%, increasing to a range of 3.4-3.6% in 2004.

The economic performance of the euro area is likely to remain disappointing in 2003 after a particularly poor outcome in 2002. Stock market declines (which have generally surpassed those in the US), high unemployment, weak consumer spending, and more fundamental structural weaknesses will continue to weigh on the euro area economies. In addition, the largest economy, Germany, and the second largest, France, are running up against the EU stability and growth pact limit of 3.0% of GDP on budget deficits, and might have to cut back expenditures in 2003. At the beginning of 2003, many consumer and business indicators, particularly in Germany, continued to show a declining trend pointing toward slow growth in the euro area in the first part of 2003. The European Central Bank is likely to cut interest rates further, following a 0.5% cut in December 2002 and a 0.25% cut in February 2003.

The euro area's growth momentum in 2003 will probably shift from reliance on exports toward final domestic demand. Combined with a more accommodating monetary policy, these developments should enable the euro area to post growth of 0.9-1.4% in 2003, further increasing to 2.4-2.7% in 2004. Similarly, in the UK, despite depressed consumer confidence at the end of 2002 and in the first months of 2003, as well as low investment spending, growth should improve in 2003 as the uncertainties associated with the Iraq conflict abate. It is expected that a supportive policy environment in the UK, both fiscal but mainly monetary (interest rates are expected to be reduced further) should lead to a significant recovery in corporate investment later in the year. GDP growth is thus forecast at 2-2.3% in 2003, further improving to about 3% in 2004.

Growth in the Japanese economy appeared to slow substantially toward the end of 2002. With sluggish growth expected in the US and euro area in the first half of 2003, the Japanese economy will recover only slowly. Deflationary expectations, stagnant nominal wages, and growing unemployment will continue to depress private consumption. Nevertheless, continued expansion in liquidity, supplementary budgetary spending, and further progress in resolving the nonperforming loan issue should allow the economy to post modest GDP growth for 2003 as a whole. Baseline assumptions are for 0.5-0.7% growth in 2003, rising to 1.3-1.6% in 2004.

The Australian and New Zealand economies are likely to continue their robust growth over the next 2 years, albeit at a slower pace than in 2002. In Australia, GDP growth is projected at 3.5% and 3.7% in 2003 and 2004, respectively, compared with 3.8% growth in 2002. Business investment, particularly nonresidential construction investment, will continue expanding rapidly in the next 2 years, while household consumption might slow somewhat. The economic slowdown is partly predicated on the continued impact of the severe drought that affected the economy in 2002.

A more marked slowdown is forecast for New Zealand, with GDP expected to expand by an annual 2.8-3% in 2003-2004 as consumption spending softens substantially and exports grow more slowly. Investment, particularly in 2003, will continue to grow faster than GDP.

Baseline Assumptions on World Trade and Key International Commodity Prices

World trade as measured by export volume rose in 2002, at a rate of 3%, sharply above the rate recorded in 2001. This upward trend is expected to continue in 2003, with growth strengthening in the range of 5-6%. Export volumes of both developed and developing countries are forecast to accelerate somewhat in 2003.

Oil prices, which averaged $25 per barrel (/bbl) in 2002 (Brent Crude Spot price) increased sharply during the first quarter of 2003, averaging $31.40/bbl, due to uncertainties related to conflict in Iraq. The increase occurred in spite of a rise in OPEC production. As the conflict started, oil prices dropped substantially. There remain considerable uncertainties related to developments in the conflict in Iraq, but it appears that major supply disruptions are unlikely. Seasonal demand for oil will also decrease in the second and third quarters of the year, at the same time that supplies from Venezuela are restored. However, commercial oil inventories at the end of the first quarter are at a 10-year low and restocking will be accelerated over the remainder of 2003. Taking all of these factors into account, oil prices are not forecast to increase significantly in 2003 compared with the 2002 average. Although the oil market could remain volatile, prices are projected on average in the range of $25-27/bbl in 2003, and to settle in a range of $21-23/bbl in 2004. The probability of a prolonged higher oil price scenario in the range of $35-40 has significantly decreased over March-April 2003.

Prices of metals and minerals (aluminum, copper, gold) strengthened a little in the closing months of 2002, and this rally continued in the early part of 2003. On average, the prices of nonprecious metals will likely be slightly higher in 2003 than in 2002.

The outlook for agricultural commodity prices is positive. Vegetable oil prices, in particular palm oil, have risen and should remain strong, supported by continued import demand from the PRC. Rice prices (Thai, 5% broken) that averaged $198.80/metric ton in the first 2 months of 2003 are expected to increase by about 5% over the rest of 2003. Grain prices, which increased sharply in 2002, are projected to remain firm in 2003. Between January 2001 and February 2003, cocoa prices more than doubled, due to continued supply disruptions in Cote d'Ivoire; prices will probably remain at current high levels in 2003. Stocks are high for coffee, cotton, and sugar, and so further price increases are unlikely. Overall, food and agricultural prices are expected to continue growing at double-digit rates in 2003 with industrial raw material prices also growing somewhat faster than in 2002, in the range of 4-5%.

Financial Market Developments

Consumer price inflation in OECD countries, estimated at 1.5% in 2002, was at a historically low level. With the strength of the recovery in industrial countries projected to be relatively weak in 2003, inflation is forecast to pick up only slightly in the OECD (to around 2%), in spite of higher oil prices in the first quarter of 2003. In the US, consumer prices rose by 3.0% in February 2003 compared with February 2002, a significant increase caused mainly by higher oil prices. The impact of higher energy prices should, however, weaken in the second and third quarters, in part as a result of lower seasonal energy demand.

Consequently, monetary policies in industrial countries will remain accommodative for most of 2003, with benchmark policy interest rates declining further in the first part of the year, particularly in the euro area. The baseline assumption is therefore for the Federal Funds rate, which averaged 1.7% in 2002, to average 1.4-1.6% in 2003.

Developments in the bond markets closely reflected expectations on monetary policies as well as the overall sentiments of weakness in the global economy. In the US, the yield curve moved down during the second half of 2002. Comparing end-June 2002 yields with those at end-March 2003 (Figure 1.6), the March curve, though still relatively steep, was flatter at the short end and the difference between the two curves was much larger at the long end. For maturities of less than 1 year, the curve dips slightly after June 2002, indicating that markets continue to expect lower rates. However, the upward slope, which is rather steep, indicates that markets expect a significant increase in rates over the medium and longer term.

The euro benchmark yield curve shows an even stronger inverted shape, downward sloping at the short end and upward sloping for maturities beyond 1 year (Figure 1.7). The market expectation is for further rate cuts by the European Central Bank. Higher yields are, however, contemplated for intermediate and longer maturities.

Over the medium term, the monetary easing might be reversed (hence the steepness of the curves) but the prospects for this appear to have receded, particularly in the US where the whole yield curve has dropped substantially since June 2002. Even with low interest rates, markets seem to expect a slow return to firmer economic growth rates.

In emerging markets, sovereign risk spreads converged in early 2003 as European and African sovereign risk fell toward Asian levels (Figure 1.8). However, the spreads for Asian markets remained somewhat below those of other emerging markets, particularly in Latin America, at the end of 2002. Hence the Asian market remains relatively attractive for investors. In the first months of 2003, substantial uncertainty and volatility continued to dominate financial markets but some improvement is likely as the year progresses.

While the PRC will continue to attract large capital flows, mainly in the form of FDI, capital flows to most other Asian countries should also improve from the 2002 rate (Box 1.3). The Institute of International Finance estimates that net private financial flows to emerging markets in the Asia-Pacific region will increase from $61.8 billion in 2002 to $62.5 billion in 2003. Of that, flows to Indonesia, Korea, Malaysia, Philippines, and Thailand would total $5.7 billion, up from $2.9 billion in 2002, though this is still well below the total of $17.2 billion recorded in 2000. Official flows are expected to remain negative as repayments exceed new inflows. While investor confidence in the region is likely to improve in 2003-2004, substantial risks still exist and FDI flows in particular will have to be closely monitored.

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