 |
Table of Contents |
 |
|
|
Asian Development Outlook 2004 Update
Developing Asia and the World
Developing Asia: Economic Highlights of 2004 and Prospects for
2005
The economies of developing Asia outperformed earlier forecasts
in the first half of 2004. While there are divergences among countries,
economic growth has been strong in all subregions, but particularly
so in East Asia and Southeast Asia. In most countries, growth has
become more broad based, with a fast-expanding external sector complemented
by robust domestic demand growth, which, significantly for the first
time since the Asian financial crisis of 1997-98, also included
business investment.
During the first half of the year, exports expanded at a surprisingly
strong rate as the recovery strengthened in major industrial countries
and intraregional trade remained buoyant. East Asian and Southeast
Asian exporters also benefited from the strong revival in the electronics
market in particular, as a result of increased United States (US)
investment demand. The strong growth momentum also translated into
fast-rising imports during the period. With some exceptions, business
investment, which had been lagging since the Asian financial crisis
in many East Asian and Southeast Asian economies, picked up in the
first half, further supporting growth in domestic demand. Relatively
robust economic growth over the past 2 years and higher capacity
utilization, surging export demand, low interest rates, and recovering
business confidence supported the pickup in investment spending.
In countries where agriculture remains a large source of employment,
the sector has generally benefited from favorable conditions, leading
to rising rural incomes and consumption, notably in the People's
Republic of China (PRC).
A feature of the first half of 2004 was that, in spite of strong
growth and high oil prices, inflation, though generally on a rising
trend, remained relatively subdued across the region. As a result,
accommodative macroeconomic policy stances remained mostly unchanged
from 2003.
While
external demand is expected to abate somewhat during the second
half of 2004 and the impact of high oil prices could be felt more
strongly in many economies, gross domestic product (GDP) growth
for the region is nevertheless projected to reach 7.0% for 2004,
slightly above the forecast of 6.8% made in Asian
Development Outlook
2004 (ADO 2004),
which was published in April this year (Table 1.1). The region's
growth will equal that of 2000, which was the fastest after the
Asian financial crisis.
Compared with ADO 2004, projections have essentially been
raised by about half a percentage point in both East Asia and Southeast
Asia, mainly on account of faster growth in Hong Kong, China; Malaysia;
Philippines; Singapore; and Taipei,China, while the expected slowdown
in the PRC will be smaller than earlier thought. In contrast, growth
in Cambodia, Indonesia, and Korea has continued to lag.
In South Asia, with the exception of Nepal, growth remains generally
robust. However, GDP growth for India in 2004 has been cut by about
1 percentage point from the ADO 2004 projection. In
Central Asia, oil exporters are benefiting from high energy prices,
while non-oil producers, such as the Kyrgyz Republic and Uzbekistan,
continue to experience slow growth. In the Pacific, there is some
improvement in the second-largest economy, the Fiji Islands, but
overall growth remains fairly low in the subregion.
Merchandise export growth in developing Asia has significantly
surprised, on the upside, the ADO 2004 forecast. In spite
of some leveling off projected for the second half of 2004, exports
are forecast to expand by 18.1% in 2004, compared with 12.4% in
ADO 2004. This follows on from a growth rate of 19.4% in
2003. However, partly as a result of higher oil prices, merchandise
imports will also increase, by 20.8% in 2004, well above the rate
of 14.8% of ADO 2004. Imports will rise very rapidly in Kazakhstan
(35%), PRC (30%), Azerbaijan (27%), Korea (27%), Thailand (27%),
Pakistan (21%), and India (20%). The region's overall current account
surplus will decline as a share of GDP to 2.8%, about half a percentage
point below the ADO 2004 projection. Notably, the PRC current
account is projected to show a deficit for the first time since
1993.
Besides external trade, the strong economic performance of many
Asian economies during the first half of 2004 was also underpinned
by a marked recovery in fixed investment, especially in Hong Kong,
China; Malaysia; Singapore; Taipei,China; and Thailand. In Korea,
Indonesia, and the Philippines, the improvement was more modest.
In Pakistan, there has been a sharp pickup in investment by the
private and public sectors, while in Azerbaijan and Kazakhstan the
rapid pace of investment in oil and gas projects continued. With
consumption expenditures continuing their rapid expansion, growth
in many countries has become more broad based with both external
demand and domestic demand contributing more evenly to GDP growth.
For 2004 as a whole, inflation in the region is projected at 3.7%,
about half a percentage point higher than forecast in ADO 2004.
The economies in East Asia and Southeast Asia will experience the
fastest acceleration in inflation, due to a combination of robust
growth and high oil prices. As shown in Part 3, some of these economies
are more vulnerable than others to high oil prices. In South Asia,
the largest economies, India and Pakistan, will also see faster
inflation, partly as a result of high oil prices. In a number of
countries in the region, inflationary pressures continue to be exacerbated
by rigid exchange rate policies that have kept import prices high
and, in some instances, have led to rapid domestic liquidity expansion.
The aggregate regional GDP growth forecast for 2005 has been reduced
to 6.2%, half a percentage point lower than in ADO 2004.
This downward revision is mainly the result of more subdued growth
predictions for the larger economies, notably India; Korea; and
Taipei,China, as well as somewhat slower growth in the PRC.
In line with some leveling off of the expansion in major industrial
countries and a further deceleration in the PRC economy, regional
exports are now projected to increase more slowly than expected
in ADO 2004. In spite of oil prices significantly higher
than in the ADO 2004 baseline, imports will rise at about
the same rate as earlier forecast, i.e., by 13.2%, but from a higher
base. The aggregate regional current account surplus will continue
to shrink to 2.1% of the regional GDP. The PRC's current account
is expected to show a deficit of 1.4% of GDP in 2005.
While the contribution of the external sector to the region's GDP
growth is expected to be reduced in 2005, macroeconomic policies
are also likely to become neutral or moderately contractionary as
domestic interest rates rise in line with world interest rates and
the margins for further fiscal stimulus in most economies are significantly
reduced. In spite of the tightening of macroeconomic policies,
inflation is forecast to rise much faster than envisaged in ADO
2004, at an annual rate of 4.4%. The pass-through of higher
oil prices will be one of the reasons. The acceleration of inflation
will be particularly marked in East Asia and South Asia.
Overall, all main economic indicators for developing Asia, with
the exception perhaps of inflation, remain bright for 2005. However,
the pickup in inflation and the weaker external trade prospects,
coming at the same time as macroeconomic policies need some tightening,
call for measures to improve the investment climate in the various
countries, enhance their competitiveness, and make them more resilient
to withstand a (possibly) substantially weaker external environment
in the second half of the decade. In addition, regional policy makers
need to support the further expansion of domestic markets, in particular
by raising the share of consumption in GDP.
Top
Global Economic Update, 2004-2005
The impressive growth performance of major industrial countries
since the second half of 2003 stretched into the first quarter of
2004, with growth projections well above trend rates for the US
and Japan in particular. Although the performance of industrial
countries has slowed somewhat since the second quarter, the baseline
for 2004 is for robust GDP growth in industrial countries at 3.5-3.9%,
about half a percentage point higher than in ADO 2004 (Table 1.2).
Projections
for 2004 have been raised substantially for Japan. For 2005 as a
whole, the baseline now indicates slower growth compared with ADO
2004, with rates settling at around potential rates. Remarkably,
for the first time since 2001, growth in major industrial countries
has become much more synchronized, a sign of the strength of the
current recovery (Figure 1.1).
Despite this, significant imbalances remain embedded in the world
economy, as growth in Japan and the euro zone has been driven largely
by a stronger external sector, itself very much dependent on strong
US expansion. But that expansion has been associated with a continued
dramatic deterioration of both the fiscal and current accounts,
as well as with historically low interest rates. These developments
make the current strong performance of the world economy particularly
prone to external shocks, whether they are prolonged, sustained,
high oil prices--most likely leading to a sharp increase in inflation--or
a loss of confidence in the US economy's ability to cope with the
deficits--most likely accompanied by a collapse of the dollar. In
industrial economies, there is little or no room left for fiscal
expansion.
These imbalances and uncertainties necessitate a monetary policy
return to a more neutral stance, in a continuation of the interest
rate move that started in the US in the second quarter of 2004.
The question is: Is the expansion in major industrial countries
self-sustaining? The risk is that a synchronized strong recovery
could turn into a synchronized slowdown. Growth prospects for industrial
countries could well start weakening more significantly toward end-2005.
Top
United States
After a strong expansion starting in the second half of 2003, the
US economy hit a soft patch in June-August this year amid rising
concerns about high oil prices. GDP expanded at a quarter-on-quarter
seasonally adjusted annualized rate (q-o-q,
saar) of 2.8% in the second quarter of 2004, after registering solid
4.5% growth in the first. The main reason was a sharp slowdown in
personal consumption expenditure, which grew by a mere 1.6% (q-o-q,
saar) in the second quarter, falling from 4.1% in the first (Figure 1.2).
However, relatively buoyant private domestic investment on the back
of healthy corporate profits and strong business activities, as
well as strengthening exports, continue to underpin the expansion
in the US economy. Industrial production is still rising, though
the earlier vigor has abated. The August Institute for Supply Management
(ISM) composite index read 59, indicating generally vigorous economic
activity, and was above 50 for the 15th consecutive month. The ISM
manufacturing index has come down from a peak of 71.1 in January,
but remains above 50 (Figure 1.3). Business activities also
expanded in the nonmanufacturing sector, according to the ISM nonmanufacturing
survey. New orders are growing, as are new export orders. Fairly
upbeat business survey results suggest that economic fundamentals
are intact, despite slowing consumption demand and rising oil prices.
Business investment rose in the first half of 2004, taking advantage
of improvements in export conditions and resilient residential construction
numbers. Gross fixed investment surged in the second quarter, growing
at 13.0% (q-o-q, saar). Corporate profits added modest gains in
the same quarter, after a strong increase in the first. Capacity
utilization is around 77%. Residential construction remained strong,
but its long sustained vigor could wane next year.
Developments in the labor market have been a major concern in the
current US recovery. Nonfarm payroll numbers surged by 353,000 in
March, and net increases averaged 295,000 a month during March to
May. However, in July, nonfarm payroll gains were only 73,000, following
a disappointing increase of 96,000 in June (Figure 1.4). Although
August saw an additional 144,000 jobs, the job market situation
in the US remains unsettled, and lack of job market growth could
eventually exacerbate the slowdown in consumption. In addition,
outstanding consumer credit, excluding mortgage debts, stood at
more than $2.0 trillion in July 2004, having risen by 7.1%
annually for the previous 5 years. Including mortgages, the
figure shoots up to an estimated $9.7 trillion or 83.7% of
GDP.
The household debt-servicing burden is also creeping up. The estimated
ratio of required debt payments to disposable income was 13.1 in
the second quarter of 2004, but a broad measure of household financial
obligations rises higher to 18.1. Hence, a household balance sheet
correction is a possibility over the medium term.
The impact of sustained high oil prices on disposable incomes,
the absence of further fiscal stimulus over the next 18 months,
as well as rising interest rates, are all likely to damp consumer
spending growth over the rest of 2004 and 2005. The Federal Reserve
will continue to raise its policy rate at a “measured” pace over this
period, with rates likely to be in the range of 3.5-4.0% by end-2005.
Inflation has remained in check, despite the threat of sustained
high oil prices. Headline inflation came in at 2.7% in August, while
the Federal Reserve's preferred core inflation measure--based on
the price deflator of personal consumption expenditure, excluding
food and energy components--was about 1.5%. Should inflation further
increase, the Federal Reserve could accelerate its tightening of
monetary policy.
Given these likely developments, the baseline GDP growth forecast
for the US economy for the whole of 2004 is 4.1-4.5%--a solid performance.
Private consumption growth will moderate over the forecast period,
as households rebuild their savings. Business investment will likely
be sustained, based on relatively sound corporate fundamentals.
Exports will support growth through 2005. In that year, economic
activity will moderate, with growth projected at 3.1-3.5%.
Top
Japan
Growth in the first half of 2004 accelerated surprisingly in Japan,
beating all projections. The external sector was the engine of growth,
but growth has increasingly become more broad based as business
investment and consumption expenditures also strengthened. Exports
to Asia rose by 19.9% in the first half of 2004 from a year earlier,
taking up the slack created by weaker demand from the US. An export-led
increase in machinery and equipment investment contributed significantly
to Japan's unexpected growth. The recovery in investment also responded
to the substantial increase in industrial production, increased
capacity utilization, and low levels of inventories.
Although
GDP growth, on an annualized basis, slowed to 1.3% in the second
quarter from 6.4% in the first (Figure 1.5), improved corporate
sector fundamentals suggest that the expansion will likely continue
for at least the rest of 2004. Public investment, though, dropped
in the second quarter, reflecting ongoing fiscal consolidation.
In contrast, private nonresidential investment continued to increase,
as corporate profits remained healthy and machinery orders surged
in the second quarter.
Corporate sector improvements slowly permeated through to the job
market. New job openings have arisen, leading to a decrease in unemployment.
However, firms remained cautious in hiring after such a long economic
slump. Many of the gains were in temporary or part-time employment,
thus limiting the recovery in wages. This picture should brighten
over the coming quarters as labor market conditions further tighten
on the back of changing demographics, although productivity growth
and corporate efforts to cope with rising labor costs will mitigate
the demographic impact. Moreover, the current escalation in production
and corporate profits will exert a positive influence on hiring
decisions.
Private consumption recovered very modestly in the first half of
2004 and will likely continue its gradual recovery. Despite the
poor performance of wage income, consumer spending maintained a
slight gain, rising 2.6% (q-o-q, saar) in the second quarter after
posting 4.2% growth in the first. The resilience of private consumption
helps support GDP growth prospects. Consumer confidence has also
been on an uptrend since the second half of 2003. With job market
conditions improving and wages picking up over the coming quarters,
the recovery in private consumption should gain firmer ground in
2005.
Deflation remains an issue. The consumer price index declined by
an average of 0.2% in the first half of 2004 from a year earlier.
The price level remained depressed despite rising oil prices and
a mild depreciation of the yen, which fell by 1.6% from the start
of the year through end-June, but the yen is still strong compared
with its level of a year ago. Although the deflationary risk will
gradually dissipate over time with a robust economic recovery, it
remains an important factor to watch with regard to the strength
and durability of the consumption recovery.
A strong export performance complemented by rising domestic demand--investment
and increasingly consumption--has led to a revision of baseline
GDP growth for Japan to 3.8-4.2%, significantly higher than in ADO
2004. As export growth moderates and business investment stabilizes
in 2005 but the gradual recovery in consumption continues, Japan
will settle to growth closer to its potential of 1.6-2.0%.
Top
Euro Zone
A mild recovery is under way in the euro
zone, driven mainly by a rebound in export demand. The euro zone
economy grew at 2.1% (q-o-q, saar) in the second quarter of 2004,
following growth of 2.6% in the first (Figure 1.6). Despite
the sustained strength of the euro, exports surged by 15.7%
(q-o-q, saar) in the second quarter following a 5.6% rise
in the first. Robust external demand boosted industrial production
across the euro zone, particularly in Germany, Italy, Netherlands,
and Spain. Business sentiment has been improving, as has manufacturing
production.
The upward trend in economic activity has also exerted a positive
influence on consumer spending. Private consumption grew by 2.4%
and 1.1% (q-o-q, saar) in the euro zone in the first and second
quarters, respectively. Reflecting the gradually broadening recovery,
together with a turnaround in consumption, GDP is expected to grow
in a range of 1.8-2.0% this year and 1.8-2.2%
in 2005.
In Germany, the largest euro zone economy, GDP grew by 2.0% (q-o-q,
saar) in the second quarter, accelerating slightly from 1.6% in
the first. Net exports contributed about 2.1 percentage points
to GDP growth in the second quarter, down from 5.0 percentage points
in the previous quarter. Domestic demand, however, continued to
stagnate in the second quarter, with consumer spending expanding
at a meager 0.3% (q-o-q, saar). On an annualized basis, capital
spending fell again by 3.4% during the second quarter, after plunging
by 14.6% in the first.
While the weakness in domestic demand in Germany remains extensive,
there are signs of improvement. Consumption, though still very weak,
has recovered from a severe contraction in 2003. Industrial production
is picking up speed, as new orders, both domestic and foreign, continue
to increase. The Ifo business climate index points to an improving
business environment, reaching 95.7 in the second quarter, though
this is a slight fall from 96.4 in the first. Based on a slow recovery
in consumption and investment over the coming quarters, the German
economy is expected to grow by 1.5-1.7% in 2004 and continue to
expand at 1.7-1.9% in 2005.
Economic growth in France is more broad based and balanced. GDP
expanded by 3.2% (q-o-q, saar)
in the first and second quarters, fueled by strong consumption and
exports. Private consumption slowed slightly to 2.9% growth (q-o-q,
saar) in the second quarter, following 3.6% in the first. A rally
in consumer spending boosted retail sales, providing a lift to industrial
production and investment. Industrial production rose further in
the second quarter, having contributed 0.8 percentage points to
GDP growth in the first. However, the increase in consumer spending
exceeded the growth in real income, making the rebound in consumption
vulnerable to developments in the job market. At present, business
sentiment is high, on the basis of increasing profits and buoyant
economic activity, which will likely enhance job market prospects.
Against this backdrop, the baseline for the French economy is to
expand at a fairly respectable 2.2-2.4% in 2004 and 2.0-2.2% in
2005.
As some of the larger euro zone economies--notably Germany and
Italy--still rely heavily on exports, the ongoing recovery remains
vulnerable. Furthermore, domestic demand performance across the
euro zone remains very uneven, limiting any scope for a harmonized
policy approach to support the tentative recovery. For example,
while gross fixed investment has improved in many euro zone countries
since late 2003, Germany and the Netherlands saw a decline in investment.
Consumer spending was particularly strong in France and Spain, but
lagged in Germany.
The hesitant recovery in consumer spending remains key to a further
strengthening of the euro zone. A major downside risk to the recovery
in consumption is the situation in the job market, particularly
at a time when unemployment benefits are being curtailed. The euro
zone unemployment rate remained static, registering 9.0% for the
fourth consecutive month in July. Policy makers' procrastination
with regard to structural reforms is partly responsible for limited
job creation in the current economic expansion. Indeed, the number
of unemployed steadily increased from 12.6 million in January
to 12.7 million in July. If job conditions do not improve as
expected, consumer confidence, which has gradually picked up since
the second half of 2003, could sharply deteriorate, clouding the
growth prospects for 2004-2005.
The headline inflation rate jumped above the European Central Bank
(ECB) target rate of 2% in the second quarter, mainly on account
of rising oil prices. Although high oil prices are a significant
risk in the short term, a slow recovery in domestic demand and a
strong euro will likely pull back inflation toward the target over
the forecast period. Nevertheless, with inflation above the target
rate, ECB will be inclined to raise its policy rate, perhaps in
late 2004 or in the first half of 2005. Fiscal policy is also constrained
by the euro zone Stability and Growth Pact. Government consumption
in the euro zone increased by 2.3% (q-o-q, saar) in the second quarter,
following 0.4% in the first, but is expected to remain restrained
over the forecast period.
Outside the euro zone, the United Kingdom (UK) grew at an above-trend
rate of 3.6% (q-o-q,
saar) in the second quarter, rising from 2.8% in the first. Domestic
demand remained strong, though consumer spending has moderated somewhat
along with what may be a less buoyant housing market. House prices,
rising at a monthly average of 1.7% during the first quarter, have
apparently started to slow in recent months. Investment recovery
is gathering pace, growing by 1.7% in the first quarter and 1.4%
in the second. Business confidence is staying high, pointing to
continued economic expansion. However, due to high oil prices, inflation
has picked up with the consumer price index rising in August by
1.3% year on year.
Robust economic expansion in the UK, coupled with tight labor market
conditions, suggests that inflationary pressures will likely remain
in place for some time. Reflecting largely buoyant global economic
conditions, the UK is projected to grow by
3.2-3.4% in 2004 and 2.8-3.0%
in 2005.
Top
World Trade and Commodity Prices
World trade expanded rapidly in the first half of 2004, owing to
a synchronized global economic recovery that was supported by strong
industrial production growth in major industrial countries and in
developing Asia. According to World Bank estimates, growth in world
trade as measured by world export volume reached 9.0% in the first
half of 2004. Drawing on the strong performance of the year to date,
world trade is expected to expand at 9-10% over the full year, before
moderating to 7-8% in 2005.
As the global recovery gained traction, imports of industrial countries
expanded in nominal terms by 18.0% in the first quarter from the
same period of a year earlier, according to the August 2004 International
Monetary Fund Direction of Trade Statistics. The value of
exports from developing Asia surged by 27.5% in the same period.
In particular, exports from the PRC grew by 34.0% in the first quarter
of 2004 from a year earlier while those from India expanded by 27.5%.
More impressively, intraregional Asian trade increased by 26.8%
to $196.3 billion in the first quarter from $154.7 billion
in the year-earlier quarter.
A cyclical upswing in high-technology industries has also boosted
world trade in 2004. Demand for information and communications technology
(ICT) products, such as wireless communications devices, digital
cameras, and consumer electronics goods, has been increasing since
late 2003. Worldwide sales of semiconductors rose to $53.4 billion
in the second quarter, increasing by 40.3% from a year earlier;
Asia posted the strongest annual sales growth at 60.9% in June,
followed by North America at 29.7%, the European Union (EU) at 28.9%,
and Japan at 26.3%. DRAM chip prices were especially firm, reflecting
strong demand and limited supply. Capacity utilization for related
products, such as integrated circuits and processors, reached over
95% worldwide in the second quarter of 2004, while inventories remained
low. According to the World Semiconductor Trade Statistics, the
world semiconductor market is estimated to grow by 28.4% in 2004,
amounting to $213.6 billion in trade value. The growth momentum
in the semiconductor and high-technology industries is expected
to moderate over the next year.
Oil prices surged in 2004 on tight market conditions and geopolitical
uncertainties (see Part 3). The latest data on oil production and
consumption suggest that tight oil market conditions are likely
to remain for some years to come. Strong demand, despite rising
oil prices, coupled with speculative positions have pushed prices
higher this year, with prices above $40 a barrel in August. The
International Energy Agency estimate for 2004 world demand, made
in August, was 82.2 million barrels a day (mb/d), representing
an increase of 2.5 mb/d in 2004. A further increase of 1.8 mb/d
is projected in 2005. World supply rose by 0.6 mb/d to 83.5 mb/d
in July. Spare capacity among members of the Organization of the
Petroleum Exporting Countries (OPEC) fell to an estimated 1.2 mb/d
in August compared with about 2.0 mb/d a year earlier. In these
circumstances, oil prices for the ADO Update
baseline have been substantially revised upward from the ADO
2004 baseline (Table 1.2). The benchmark Brent crude price is
put at an average of $36-38 a barrel in 2004, easing somewhat to
$33-35 in 2005.
Prices
of non-energy commodities stayed high during the first half of 2004
(Figure 1.7) as a result of the strong global recovery and
sustained demand from the PRC, particularly for raw materials and
metals. Prices of raw materials, including timber and rubber, further
increased in the first half, with the notable exception of cotton,
which sharply declined due to recent favorable output forecasts
for 2005. Although still at relatively high levels, rubber prices
started to stabilize in July. Overall, the World Bank price index
of raw materials increased 15.2% year on year in the second quarter,
following a 13.8% rise in the first. Prices of metals and minerals
surged by 41.5% in the second quarter from a year earlier. Steel
prices shot up by 68.3% over the same period, while prices of other
metals such as copper, lead, and tin, all rose by more than 50%.
Agricultural and food commodity prices have generally eased recently,
as forecasts for the next crop year have mainly been strong. Prices
of grains, including maize, rice, and wheat, which had posted strong
gains in the previous 12 months, started to retreat in July on the
back of favorable crop prospects. The price rally in fats and oils
seen in 2003 reversed during the first quarter and continued to
stabilize, as supply conditions improved. Coffee prices continued
recovering in the first half, while cocoa prices fell sharply in
the second quarter, due to a freer price regime in the Côte
d'Ivoire, the world's top producer of cocoa. Fertilizer prices remained
firm.
Looking forward, the prices of non-energy commodities, though stabilizing,
are likely to remain relatively high in 2005 as demand from developing
Asia, and the PRC in particular, appears to have shifted the demand/supply
dynamics in commodities markets in a fundamental way. Despite a
moderation of cyclical demand later this year, non-energy commodity
prices are estimated to increase by about 5-6% in December 2004
from December 2003.
Top
Financial Market Developments
Around midyear, global financial markets had generally cooled,
as the strong expansion in the world economy softened in the second
quarter of 2004. The bullish runs in equity prices since the latter
half of 2003 paused in July and August to reassess the strength
of the global recovery. Bond yields, which edged higher in April
and May on anticipation of a phased monetary tightening, fell back
in July and August.
Despite
healthy earnings in major industrial countries in the second quarter,
concerns about growth prospects over the medium term, together with
high oil prices, depressed equity prices around the globe (Figure 1.8).
A moderation in global ICT industry earnings further led to a weakening
of markets in July and August. Finally, reflecting less certainty
in a strong growth outlook, long-term government bond yields in
the US and EU have come down. Yield curves have generally flattened.
While policy rates around the world are still very low, central
banks in major industrial countries have increasingly weighed the
risk of inflated asset prices and high oil prices in deciding monetary
policy. During the first half of 2004, surging oil prices put upward
pressure on overall consumer price levels in major industrial countries
except Japan, though core inflation has remained relatively subdued.
At the same time, the strength of the world economy in general and
the US economy in particular made the case for a tightening of monetary
policy more compelling.
The Federal Reserve raised the target Federal Funds rate in June,
August, and September, each time by 25 basis points, to 1.75%. (The
central banks of Australia and the UK had raised rates earlier.)
On the assumption of no sharp acceleration in inflation, the Federal
Reserve is expected to continue raising its policy rate at a “measured”
pace over the forecast period with the rate projected to reach 3.5-4.0%
by end-2005. This is slightly higher than the baseline rate in ADO
2004. Based on the gradual increases at least until the first
half of 2004, the 6-month London interbank offered rate is projected
to reach 3.0% by June 2005, while, after more than 15 months of
keeping the target rate at 2.0%, ECB is now also likely to raise
its policy rate in the near term as inflation in the euro zone reached
2.3% in July and as a stronger recovery takes hold there. The December
futures for 3-month Euribor, priced at a discount rate of 2.3% as
of 9 September, also point to a rate rise in early 2005. The
Bank of Japan is struggling with deflation, which makes it unlikely
that the zero-interest rate policy will change soon. As private
consumption is yet to prove self-sustainable, the Bank of Japan
will certainly wait until domestic demand pressures have a visible
impact on inflation.
Although
financial markets had expected a rein-in of very expansionary monetary
policy for some time, uncertainties surrounding the turn of the
monetary cycle nonetheless fueled financial volatility in April
and May. Volatility for 3-month
US treasury bills surged and remains high, reflecting unsettled
issues on the outlook for the US economy and its impact on further
interest rate increases (Figure 1.9). On the other hand, the
volatility of 10-year US treasury notes has steadily decreased,
indicating well-anchored inflationary expectations based on modest
economic growth and the Federal Reserve's clear intention to curb
future inflationary pressures.
The
impact of a US interest rate rise was felt more severely in emerging
financial markets. Exceptionally low interest rates in support of
the global recovery in 2003 heightened institutional investors'
risk appetite and led them to take on more leverage and venture
into riskier assets. Emerging markets, particularly Asian equity
and fixed-income markets, benefited from these speculative inflows
throughout much of 2003 until mid-March
2004. As a result, equity prices bounced back from their
lows and sovereign bond credit spreads narrowed sharply in the latter
half of 2003 through March 2004. Against this backdrop, the prospect
of rising short-term interest rates, together with the emergence
of more attractive safe assets in mature markets, triggered a broad
unwinding of speculative positions in emerging financial markets.
A heavy sell-off of emerging market assets during April and May
resulted, sharply lowering equity prices and widening credit spreads
across Asia. Higher oil prices and the prospect of a slowdown in
the PRC further weighed on investor confidence in Asia: equity market
indexes across Asia fell in the second quarter (Table 1.3).
Asian bond prices in general retreated from the rally seen in the
second half of 2003, leading their credit spreads to widen more
than those of high-yield corporate debt in mature markets (Figure 1.10).
New offerings from Asian issuers, which surged in the first quarter
of 2004 to take advantage of favorable funding conditions prior
to the rate increases, continued in the second quarter. Major issuers
of emerging market sovereign bonds, including the PRC and Korea,
also frontloaded their funding programs for the year. Overall the
prospects for capital flows to the Asia-Pacific region remain positive
over the forecast period as economic growth in the region is expected
to be robust.
Since midyear, emerging markets have been on the rebound. In contrast
to weakening sentiment in mature markets, growth fundamentals in
emerging Asian markets remain strong, providing support for higher
equity and bond prices. Equity prices recovered some of the losses
and emerging market spreads narrowed in July and August 2004. Capital
flows resumed, in the form of syndicated loans and portfolio investment.
Despite the large twin deficits in the US, the dollar's depreciation
against other major currencies and Asian currencies came to a halt
in the first quarter of 2004 and started to reverse slowly in the
second.
The unwinding of speculative positions in riskier assets appeared
to favor the US currency, as institutional investors and hedge funds
reduced their emerging market positions, switching back into dollar
assets. Historical evidence also shows that higher oil prices tend
to accompany a stronger US dollar, mainly due to increased demand
for dollar-denominated assets by oil-exporting countries.
The relative strength of the US dollar will likely be sustained,
at least in the short term, as uncertainties surrounding oil price
developments continue. However, downside risks to the dollar remain
significant in the medium and longer term, mainly due to the large
macroeconomic imbalances in the US. Large US current account deficits
require substantial capital inflows to be sustained, and these inflows
have increasingly been supplied by Asian central banks, appearing
as large increases in their official reserves. A faltering of the
US recovery could significantly change investor sentiment toward
US assets. A reversal of capital flows away from the US, though
more of a medium-term risk, could trigger a steep slide in the dollar,
as well as a sharp rise in long-term bond yields.
Top
Developing Asia:
Subregional Trends and Prospects
East Asia
East Asian economies posted strong growth averaging 8.4% in the
first half of 2004, helping lift the overall growth rate for developing
Asia. The surge in exports in the second half of 2003 continued
into 2004, and was joined by a strong pickup in domestic demand
in most of the economies. Despite macroeconomic tightening in the
PRC, its GDP expanded by 9.6% in the first half, slowing by just
0.2 percentage points between the first and second quarters. The
economies of Hong Kong, China and Taipei,China also prospered, with
GDP growth of 9.5% and 7.2%, respectively.
Higher levels of investment have been a major driver of growth
in the PRC; Hong Kong, China; and Taipei,China. In the PRC, investment
growth slowed in the second quarter, but was still high at 22.3%.
Private investment surged in Hong Kong, China and Taipei,China,
fueled by strong exports, increased corporate profits, rising capacity
utilization, and low interest rates. Consumption growth in the PRC
strengthened as a result of rising urban and rural incomes. In Hong
Kong, China and Taipei,China, too, private consumption rose
after several sluggish years, spurred by the recoveries in labor
and property markets.
Merchandise exports from the subregion, particularly of IT products,
are forecast to rise by about 20% in nominal US dollar terms over
all of 2004, or 7 percentage points faster than projected in ADO
2004. Merchandise imports also are much stronger than expected
because of higher oil prices, stronger consumer demand, and East
Asia's hunger for industrial inputs to its export sectors. Import
growth for the full year will be around 23%, also 7 percentage points
above the earlier projection. The contribution of net exports to
GDP growth has declined in the PRC; Hong Kong, China; and Taipei,China,
as growth in imports outpaces that in exports. At the same time,
the contribution of domestic demand to GDP growth has increased
in all three economies. The subregion's current account surplus
will fall to 2.3% of GDP, half the level recorded in 2003. Korea's
experience is less encouraging. Its exports are buoyant but domestic
demand remains weak. Private consumption is constrained by a heavy
household debt burden. Its gross fixed capital formation increased
only moderately in the first half of 2004. As a result, Korea's
GDP grew by 5.4% in the 6 months, well below the pace of the other
three economies.
Strong domestic demand and high oil prices revived inflation in
the PRC and Taipei,China. Price deflation concerns faded during
the first half in Hong Kong, China, and year-on-year inflation was
recorded in July for the first time since late 1998. Korea's inflation
rate picked up because of higher oil prices and wage pressures,
despite its weak domestic demand. The projection for average inflation
for the subregion is raised to a still moderate 3.0% for 2004.
In view of improved economic performance, most East Asian governments
cut back on fiscal and monetary stimuli. The PRC Government used
monetary, fiscal, and administrative measures to slow investment
in sectors that it considered overheated.
In order to achieve more balanced growth and to avoid a hard landing,
the PRC Government also adopted measures to lift growth in lagging
sectors as well as in poorer provinces. The authorities in Hong
Kong, China pledged to rein in the deficit in the medium term and
are considering a broad-based goods and services tax as a way to
stabilize revenues. In Taipei,China, a Ministry of Finance tax reform
committee proposed increasing the value-added tax, and a new pension
reform package was passed to address fiscal and social security
issues. In Korea, on the other hand, fiscal and monetary policies
have remained expansionary in an effort to bolster domestic demand.
The Bank of Korea lowered its policy interest rate, while the Government
introduced a supplementary budget and is considering a further fiscal
package.
For all of 2004, aggregate GDP growth in East Asia now is forecast
at 7.3%, nearly half a percentage point higher than in ADO 2004.
Going into 2005, growth is projected at 6.4%, with downward revisions
for the PRC and Korea. That puts next year's expected subregional
growth about 1 percentage point below this year's.
Export growth in 2005 will slow from 2004's rapid pace, but will
remain robust at about 13%. Similarly, the burst in imports will
decelerate. The subregion's current account surplus will shrink
further to 1.4% of GDP. Domestic demand is expected to remain strong
in most of the economies. In the PRC, investment growth is slowing,
though the large amount of construction approved or ongoing means
that growth in investment will remain high. Consumption growth will
be robust thanks to increased household incomes. GDP is forecast
to rise by 8.8% in 2004, up from the ADO 2004 figure of 8.3%,
while growth in 2005 has been revised down slightly to 8.0% from
8.2%.
Investment spending in Hong Kong, China and Taipei,China is expected
to remain robust, while consumption will be strong on the back of
the continuing recovery of the labor and property markets. GDP growth
for Hong Kong, China is revised up to 7.5% in 2004 and 6.0% in 2005,
from 6.0% and 5.0% in ADO 2004. For Taipei,China, forecast
growth is raised to 6.0% in 2004 and 4.8% in 2005, from the 5.4%
and 4.7% in ADO 2004. Exports from all three economies are
likely to expand briskly, although import growth will surpass that
of exports.
In Korea, a sluggish recovery in domestic demand and moderation
of export growth have led to a downward revision in growth forecasts
to 4.4% in 2004 and 3.6% in 2005, compared with the ADO 2004
forecasts of 4.8% and 5.2%. Thus, expansionary macroeconomic policies
are likely to continue in Korea, as will the effort to reduce the
household debt problem. Policy makers should also refocus on reforms
to promote economic efficiency and productivity, through greater
flexibility in the labor market, a healthier credit culture, and
improved governance in the corporate sector.
Macroeconomic policies will remain broadly neutral in the PRC;
Hong Kong, China; and Taipei,China in the short term, although central
bankers will be watching the return of inflation. In the subregion,
inflation is expected to rise, averaging 3.8% in 2005, with this
figure heavily influenced by a 2 percentage point increase in the
projection for the PRC's price levels. So far, the central bank
in the PRC has avoided using higher interest rates as a way to stem
investment, though interest rates may well be raised if inflation
exceeds 5% for an extended period.
Top
Southeast Asia
The rebound of economic growth in Southeast Asia was impressive
in the first half of 2004. The subregion's GDP growth for 2004 is
now estimated to reach 6.2%, half a percentage point higher than
in ADO 2004, and up from about 4.5% growth over the past
2 years. The economies of Malaysia and Singapore performed well
above expectations while those of Thailand and Viet Nam continued
to show healthy growth. In Indonesia, the largest economy in Southeast
Asia, and the Philippines, growth in 2004 has also been improving,
though at a more moderate pace.
A combination of domestic and external factors contributed to the
better than projected performance of most Southeast Asian economies
during the first 3 quarters of 2004. The same combination is expected
to continue to drive growth for the rest of 2004 and well into 2005.
First, with robust growth in most industrial countries, continued
strong demand from the PRC, and the brisk revival of the electronics
industry, exports from Southeast Asian countries expanded substantially
faster than forecast in ADO 2004. In nominal US dollar terms,
exports are expected to jump by nearly 14% for the subregion, about
4 percentage points above the ADO 2004 forecast. With the
notable exception of Indonesia, exports grew well into double digits
in most countries in the first half of 2004. Indonesia's net oil
and gas exports declined by 26% in the first half, mainly due to
declining production. Both agricultural and manufactured exports
from Southeast Asia grew rapidly.
While net exports were a significant contributor to overall GDP
growth in Indonesia, Malaysia, Singapore, and Thailand in 2003,
data for the first 2 quarters of 2004 mostly show that net exports
have subtracted from GDP growth in all countries except the Philippines.
Indeed, strong domestic and external demand as well as the impact
of higher oil prices led also to a sharp double-digit increase in
imports in Southeast Asia. In the Philippines however, imports will
expand moderately in 2004.
For the subregion, total imports in US dollar terms are forecast
to rise by 16.8% in 2004, about 5 percentage points higher than
projected in ADO 2004. With imports rising much faster than
expected, the subregion's current account surplus will shrink to
7.2% of GDP, about 1 percentage point below the ADO 2004
projections. For Malaysia, Singapore, and Thailand, the surplus
remains substantial, while Cambodia is forecast to run a current
account deficit of about 10% of GDP, about the same as in 2003.
Second, compared with the analysis in ADO 2004, a major
emerging new feature of the economic developments in Southeast Asia
during the first half of 2004 was, for the first time since the
Asian financial crisis, a marked revival of business investment
in most countries. Investment growth is projected to remain strong
over the rest of 2004. Higher capacity utilization, good progress
in the resolution of nonperforming loans, low interest rates, and
a revival in construction have led a significant pickup in business
investment in many countries. In Indonesia, Malaysia, Philippines,
and Singapore, total investment contributed positively and substantially
to growth after several quarters of negative contributions. In Malaysia,
investment contributed 3.9 and 5.1 percentage points to GDP growth
in the first and second quarters, respectively. In Singapore, the
contribution was 8.4 and 5.1 percentage points, respectively, after
a negative contribution throughout 2003. In Thailand, capacity utilization
surpassed precrisis levels for automobiles, electrical appliances,
electronics, and steel. In Indonesia and the Philippines, investment
recovered also but to a lesser extent. In both countries, there
was a pickup in construction investment, but in the Philippines,
investment in durables also rose. Complementing the strong performance
of private consumption expenditures over the past few years, the
revival of private business investment growth in Southeast Asia
was a long-awaited and welcome development. It augurs well for longer-term
subregional growth.
Sustained demand, combined with higher oil prices, nudged up inflation
throughout Southeast Asia, with average inflation now projected
at 4.2% for 2004, about half a percentage point higher than projected
in ADO 2004. Inflation thus remains quite moderate in the
subregion, particularly in Malaysia, Singapore, and Thailand. Monetary
policies are thus projected to remain accommodative over the year,
although as was the case in Thailand, some interest rate increases
to align with those in the US will occur.
While a more positive growth environment could have led to some
fiscal consolidation, this has not occurred so far. Fiscal deficits
as a share of GDP are low in Indonesia and Thailand. Although it
has a small and shrinking fiscal operating deficit, the overall
budget of Singapore has a surplus of about 3.6% of GDP. However
in other Southeast Asian countries, the deficits have been sizable
for many years, in particular in Cambodia, Lao People's Democratic
Republic (Lao PDR), Malaysia, Philippines, and Viet Nam. Public
debt has also been accumulating. Policies to improve fiscal balances
will need to be put in place and will affect the short- and medium-term
outlook for Southeast Asia.
Projections for the subregion in 2005 indicate another year of
robust growth, albeit at a slightly lower rate than in 2004. GDP
is forecast to expand by 5.7%, with the fastest growth in Lao PDR,
Malaysia, Thailand, and Viet Nam. Following elections in 2004,
a return of confidence in the economy will also lift Indonesia's
GDP growth to the highest level for at least 5
years, while growth is projected to be higher than forecast
in ADO 2004 for the Philippines. Singapore's economy should
return to more sustainable trend growth.
In line with the baseline assumption of lower world economic growth
and a further slowdown in the PRC, exports will rise at a more moderate
rate of about 8.5%. With domestic demand projected to remain strong,
imports will continue to rise somewhat faster and as a result the
subregion's current account surplus will shrink further to a still
comfortable 6.6% of GDP.
The major contribution to sustained growth in the subregion will
come from domestic demand, both consumption and investment. Strong
consumer sentiment will support further increases in private consumption
spending. At the same time, the current improvements in investor
sentiment are expected to continue underpinning robust growth in
fixed investment over 2005.
A marked increase in capacity utilization in 2005, a more stable
political environment in several Southeast Asian countries following
peaceful elections in 2004 (notably Indonesia and the Philippines),
as well as some improvement in the investment climate will spur
business investment in 2005. In spite of relatively high oil prices,
inflation is not forecast to accelerate significantly in 2005, and,
as a result, monetary policies will remain generally neutral. Some
fiscal consolidation will be effected notably in the Philippines
and Malaysia, but this would have only a small impact on the outlook
for 2005.
Top
South Asia
A return of favorable weather in 2003 in South Asia led to a remarkable
agricultural recovery and a surge in GDP growth to 7.6%. ADO
2004 projected more moderate but still high growth for the subregion
at 7.0% in 2004 and 7.2% in 2005. These forecasts are now revised
downward to 6.4% in 2004 and 5.9% in 2005. Less favorable weather
conditions in 2004, price pressures (mainly in oil and metals),
and a less buoyant outlook for global growth in 2005 are the main
factors underlying the downward adjustments. In addition, inflation
in the subregion has been repegged at somewhat higher rates--at
5.5% in 2004 and 6.5% in 2005. Estimates for the balance-of-payments
outlook continue to show strength with trade expanding at double-digit
rates in most countries. South Asia as a whole is expected to continue
to record a current account surplus.
In India (accounting for about four fifths of the subregion's GDP),
developments through August suggest that a weak and erratic monsoon
will lower agriculture sector growth not only to below that of the
sharp rebound expansion in FY2003 (ended 31 March 2004) but also
below its trend rate of growth. This would markedly lower growth
in personal income and consumption from the robust expansion in
that year. Moreover, wholesale price index (WPI) inflation accelerated
sharply to just over 8% by end-August, largely reflecting rising
prices of oil, iron and steel, and coal. To temper price pressures,
the Government responded in August by cutting excise and import
duties on selected commodities and fuels. Subsequently, in September
the Reserve Bank of India, which had intended to continue an accommodative
monetary policy for FY2004, announced an increase in the reserve
requirement ratio to 5%, effective 2 October, an action that will
likely raise interest rates, limit bank lending, and restrain growth.
Taking these developments into account, FY2004 estimated agricultural
growth in India has been downgraded to 2% while expansion in industry
and services has been reduced to 7.8%, to yield revised GDP growth
of 6.5%. For FY2005, GDP growth of 6.0% is now expected. This projection
is based on a normal monsoon but a slowing expansion in industry
and services, reflecting expected developments in the Indian business
cycle. For FY2004, average WPI inflation is estimated at 5.7% and
is projected to rise to 6.8% in FY2005 due to a full pass-through
of the previous year's price increases.
The new United Progressive Alliance Government that took office
in May has announced its National Common Minimum Program that emphasizes
economic reform with a “human face”. The main goals include generating
employment and stimulating pro-poor growth, increasing rural credit
and social spending, and stepping up investment in physical infrastructure.
The (full-year) federal government budget for FY2004 released in
July 2004 sought to implement some of these goals while reducing
the revenue and overall budget deficits. Nevertheless, weaknesses
in state government finances are expected to keep the consolidated
government budget deficit at about 10% of GDP. Comprehensive steps
toward much-needed fiscal deficit reduction are expected to be taken
in FY2005.
In Bangladesh, GDP growth is estimated at 5.5% for FY2004 (ended
30 June 2004), driven by steady growth in export-oriented industrial
production and the services sector. Macroeconomic policies
kept to a cautious tack; inflation that had been on the rise during
the year was checked and held to 5.6%. Export growth rebounded sharply
(15.9%) and, while imports also rose, growth in worker remittances
and official transfers kept the current account in surplus. Policy
reforms adopted with the FY2005 budget included the following: measures
to expand income tax and value-added tax coverage; rationalization
of customs duties to moderate tariff protection and promote efficiency
of domestic industry; and adjustment of interest rates on National
Savings Certificates to foster greater flexibility and market orientation.
The outlook for Bangladesh GDP growth in FY2005 has been revised
downward to 4.8% (from 6.0% in ADO 2004) due to the devastating
floods in July and August that severely damaged agricultural activities,
infrastructure, and industry. Inflation is now projected to be 6.0%
while the current account balance is likely to be pushed to a deficit
of 1.5% of GDP as a result of the calamity. Macroeconomic management
will be challenged, especially if recovery in food and other production
takes an extended time. Since Bangladesh relies heavily on Multifibre
Arrangement (MFA) quota-restrained markets, the abolition of quotas
at year-end seriously threatens to undermine the country's textile
and garment exports (75% of total exports) and consequently employment
levels. This is because effective competition by the industry in
the global market is hobbled by low productivity, inadequate infrastructure,
and policy constraints.
Nepal's economy grew by only 3.6% in FY2004 (ended 15 July 2004),
mainly due to the breakdown of the cease-fire with the insurgents
in August 2003. Industry underperformed, expanding by only 1.8%
with minimal growth in construction. Agricultural output strengthened,
with paddy production up 7.8%, while some improvement in tourism
lifted the services sector. The continued insurgency hit government
activity, causing a 16% shortfall in development expenditures. An
ongoing deterioration in the investment climate was reflected in
weak growth in credit to the private sector and a fall in interest
rates for the second consecutive year.
A new prime minister, appointed in June, has formed a coalition
Government that enjoys support from some political parties, despite
the fact that Nepal's Parliament remains suspended. The FY2005 budget
announced in July aims to implement the Government's poverty reduction
strategy and to raise expenditure allocations to local-level, community-led
projects as part of its effort to boost development expenditures
and reform. Apart from this stimulus, monetary policy is to be accommodative
so as to support a stronger economic expansion. Assuming no substantial
deterioration in the security situation, GDP is forecast to grow
by 3.7% in FY2005, underpinned by a favorable monsoon, and by some
pickup in construction and manufacturing.
Pakistan's economic reforms of the past 4 years have made a major
contribution to a stronger economy. GDP growth accelerated to 6.4%
in FY2004 (ended 30 June 2004), with manufacturing accounting for
half of the expansion. The current account of the balance of payments
remained in surplus for the fourth straight year, though at a lower
level. With macroeconomic reforms and policies on a sound footing,
the FY2005 budget and the trade policy continued the structural
adjustment process and moved on to second generation reforms. Measures
were taken to accelerate growth in agriculture, industry, housing
and construction, and business activities--and to further improve
tax administration. The measures largely involved tax and tariff
rate cuts and new financial incentives, but also included steps
to reduce the harassment of business by government regulators.
With private investment in Pakistan picking up and a sizable increase
in the public sector development program, GDP is estimated to grow
by 6.5% in FY2005, up from 5.8% projected in ADO 2004. Notwithstanding
an expected gradual tightening of monetary policy that will raise
interest rates, inflation is now estimated at 5.5% for the year,
reflecting a buildup in domestic liquidity in recent years and the
fact that industries
are approaching full capacity utilization. Rapid economic growth
and continued high oil prices will widen the trade deficit, and
the current account is now expected to switch to a deficit of about
1.3% of GDP in FY2005. Over the longer term, restructuring and modernization
of the textile and garment industries have helped prepare the country
to be competitive in the post-MFA quota era.
Top
Central Asian Republics
In the six Central Asian republics (CARs), developments through
midyear confirm that 2004 will be a year of continued rapid growth,
as projected in ADO 2004. Economic performance remains driven
by large investments in the oil and gas sector as well as by higher
oil prices and gas sales in some countries. Additionally, higher
prices for non-oil export commodies, especially for cotton and for
gold and other metals, have, to varying degrees, boosted economic
expansion in all countries in the subregion.
Economic growth for 2004 in the CARs as a whole is now estimated
to be 7.9%, marginally lower than in ADO 2004 with all countries
but one expected to meet or exceed the original growth forecast.
In summary: growth fueled by the oil and gas sector has supported
rapid GDP expansion in Azerbaijan (10.0%), Kazakhstan (9.5%), and
Turkmenistan (10.0%) while export commodity-led growth prevails
in the Kyrgyz Republic (4.5%), Tajikistan (8.5%), and Uzbekistan
(3.0%). The Kyrgyz Republic and Tajikistan are implementing poverty
reduction growth strategies supported by international financial
institutions and other aid partners. Despite achieving current account
convertibility in 2003, economic growth in Uzbekistan remained low
and well below potential as implementation of its policies for market-based
structural reforms has been slow. Prospects may be enhanced following
announcements that, over the next 5 years, the PRC and the Russian
Federation aim to invest a combined total of about $3 billion
in Uzbekistan in various sectors, which could be the catalyst for
a growth breakthrough.
Most countries have experienced a modest uptick in inflation from
2003 actual and ADO 2004-projected levels, mainly because
of robust expansion in investment and consumer demand. Nevertheless,
the revised estimate for subregional average inflation in 2004 remains
moderate at 6.4%, with individual country performance narrowly bunched
around this average. This average is somewhat lower than the ADO
2004 projection largely because inflation in Uzbekistan is now
estimated at about 10%, well below the earlier projection, though
inflationary imbalances there are still to be unwound. Growth in
employment continues to be limited, in some countries by the capital-intensive
nature of oil and gas sector-led development and in all countries
by difficulties in achieving structural adjustments necessary to
achieve broad-based rapid growth.
With higher than expected oil and commodity prices so far in 2004,
export earnings in the CARs have expanded more rapidly than projected
in ADO 2004. Increased earnings, however, have been offset
by higher imports and larger net deficits on invisibles, especially
larger oil sector payments for services, outflows of repatriated
profits, and foreign labor remittances.
For the subregion, the current account deficit for 2004 is now
estimated at 3.9% of GDP, slightly above the ADO 2004 projection.
Current account deficits are covered by foreign direct investment
in Azerbaijan and Kazakhstan where large oil and gas development
projects are under way, and by development aid and other capital
flows in the other CARs. Azerbaijan's current account deficit in
2004, estimated at about 35% of GDP, is an extreme outlier among
the CARs, reflecting heavy expenditure on four major oil and gas
projects near completion in a relatively small economy.
The outlook projected for the CARs in 2005 is for a continuation
of rapid GDP growth of about 8%. The pace of growth in individual
countries is expected to be largely similar to that estimated for
2004, though in the Kyrgyz Republic and Tajikistan a modest improvement
over the ADO 2004 forecast is now expected as structural
reform takes hold. Both these countries face intrinsically difficult
economic circumstances and weak resource bases.
Governments are likely to maintain their generally cautious monetary
and fiscal policies, and inflation is expected to moderate to an
average of 6.4% for the subregion with essentially all countries
improving on the 2004 projected outcome. Despite moderation in oil
and commodity prices and slower growth in exports and imports, the
current account deficit for the subregion is forecast to be about
2% of GDP in 2005, about half the 2004 projected outcome. This mainly
reflects some moderation in oil and gas sector investment activity.
A major issue facing the CARs is to diversify from their heavy
dependence on oil and gas or a few non-oil sector commodities. Further
structural reform and a broadened economic base will be necessary
to maintain the sustainable, high growth necessary to generate the
needed employment opportunities and reduce poverty.
Top
Risks to the Outlook for Developing Asia
ADO 2004 identified various risks to the economic outlook,
including global and regional economic risks, as well as terrorist
outrages. In addition, the threat of various epidemics, most recently
avian flu, appears to have become a recurrent concern. In short,
the risks analyzed in ADO 2004 are still relevant in September
2004, with perhaps, some adjustments required to the likelihood
and dates of the economic risks occurring.
Global Economic Risks
At the time of writing ADO 2004, the quality and breadth
of the recovery in industrial countries remained unclear, mainly
due to weak employment generation, the prospects of rising inflation
(associated with upward movements in oil and commodity prices),
and the uncertainty of the timing and impact of the projected rise
in interest rates from historically low levels. Over the medium
to longer term, the ballooning US fiscal and current account deficits
were seen as exacerbating the risks to the world recovery.
By the third quarter of 2004, growth in industrial countries--the
US and Japan in particular, but also increasingly in the EU--has
gained momentum and remains quite solid, while in developing Asia,
growth is healthier than forecast earlier in the year.
In spite of higher oil prices for most of 2004, core inflation
in major industrial countries remains little affected and, as a
result, inflationary pressures are generally subdued. Although employment
generation has been much softer than usual in this cyclical recovery
in the US, the apparent strength of the growth momentum has persuaded
the Federal Reserve to start raising interest rates earlier than
previously expected. Despite this, and contrary to the fears expressed
in ADO 2004, no significant disruptions have occurred in
financial markets. Although policy rates in all industrial countries
are still extremely low, the cycle of progressive monetary tightening
will continue and will likely accelerate at least in the US in 2005,
especially if inflation picks up. Similarly, ECB could raise rates
earlier than previously expected. With major industrial countries
forecast to continue growing above trend over the rest of 2004 and
the first half of 2005, an acceleration of monetary tightening will
depend significantly on changes in inflation rates.
The impact of high oil prices, possibly sustained well into 2005,
needs to be evaluated. Faster oil-induced inflation would require
a sharper tightening of monetary policy in major industrial countries.
The danger inherent in such tightening is partly that it could affect
a recovery still rather uncertain in its self-sustainability. The
outcome for the world economy, and industrial countries in particular,
would then depend on a continued domestic consumption recovery and
strengthening of business investment. The risks of a faster deceleration
in growth in major industrial countries in the latter part of 2005
remain a distinct possibility.
The huge macroeconomic imbalances in the world economy--mainly
the twin US deficits but also imbalances in Japan and the EU--have
been left unresolved during the 2003-2004 recovery cycle. As 2005
advances and in 2006, these imbalances that are characterizing the
current recovery cycle could start dragging down world growth, due
both to sharply higher interest rates and to a substantial depreciation
of the dollar. They could impact on growth as renewed inflationary
pressures, stemming from sustained high oil prices, trigger policy
tightening. Moreover, an extended period of slow growth in output
and employment, especially if accompanied by inflationary pressures,
would risk a rise in trade protectionism that would throttle what
has been a main impetus to global expansion. Taken together, these
elements hold significant risks for the world economy over the medium
term.
As noted in ADO 2004, it will be important for developing
Asia to evaluate the impact of these possible negative outcomes,
since they could well spell a return to a period of stagflation
in the second half of the decade. Domestic policy adjustment and
reforms need to be carried out now while growth is robust. One policy
shift to consider is to increase domestic consumption demand in
supporting growth in the context of making economies more open.
As the experience in some countries of the region has shown in recent
years, this requires a continuation of economic reforms, particularly
in the financial sector.
Top
Regional Risks
ADO 2004 identified a set of risks specific to the region.
All are still in place. However, many of these risks also represent
opportunities, such as the surge in intraregional trade, the increasing
importance of domestic consumption demand as a driver of growth,
and the accumulation of large amounts of foreign reserves by many
Asian governments.
Intraregional trade dynamism continued as a major feature of the
outlook in the first 3 quarters of 2004. It is likely to remain
so over the forecast period under the current baseline projection
that the PRC economy will achieve a soft landing. While the PRC
is projected to expand robustly at least in 2004, a steeper slowdown
in 2005 is possible. Investment is still growing fast in many sectors,
and at the same time inflation has been rising substantially to
about the central bank's intervention point of around 5%. A greater
tightening of policy, including monetary policy, might be needed
in late 2004 or 2005. However, an interest rate rise and a deterioration
of the growth environment could lead again to a substantial surge
in nonperforming loans, possibly affecting the medium-term economic
outlook.
As discussed in Part 3, a slowdown in the PRC's growth rate by
2 percentage points would cut GDP growth in East and Southeast Asia
by about 0.2-0.5 percentage points. Hong Kong, China would
feel the impact more, at close to 1 percentage point. However, combined
with a simultaneous slowdown in the US and Japan, the impact on
East and Southeast Asia would be in the range of 0.5-1.0 percentage
points (again, except Hong Kong, China where the impact could be
about 1.4 percentage points). These possible scenarios highlight
the need for many governments in developing Asia to consider medium-term
policies aimed at expanding the role of domestic consumption demand
in sustaining growth.
However, the experience of Korea over the past 2 years shows that
weaknesses in some areas of financial sector regulation and supervision
can easily result in a sharp increase in household debt, and, possibly,
in a consumer debt crisis. The Bank of Thailand, for instance, in
2004 tightened its credit card regulations in seeking to preclude
a Korean-type crisis. As mentioned in ADO 2004, the importance
of deepening financial sector reforms, including the development
of nonbanking financial institutions in developing Asia, is highlighted.
In an environment of rising international interest rates--even if
rates remain low in a historical perspective--and mounting household
debt in some countries, the urgency to accelerate such reforms is
evident.
Looking at possible scenarios for the world economy over the medium
term, many regional governments should use the current opportunity
of robust economic growth projected in 2004-2005 to undertake reforms
to consolidate their fiscal situation and reduce public sector indebtedness.
Following the 2001 world recession, many Asian countries have indeed
pursued expansionary fiscal policies to support economic growth.
Outside these countries, mainly in South Asia, the Pacific, as well
as the Philippines, large budget deficits have been common for many
years. As a result, public debt-to-GDP ratios have been rising and
have reached worrisome levels in several countries. As interest
rates rise and economic growth slows over the medium term, the public
sector's debt-servicing burdens will increase, leaving little room
for possible fiscal support. Also, if robust growth is to be maintained
in the region, business investment needs to expand substantially
over the next few years. However, in a higher interest rate context,
large fiscal deficits will crowd out private investment.
ADO 2004 also warned of the need to translate growth into
employment generation and to address widening income inequalities.
Developments in the first half of 2004 have confirmed the need to
address these concerns, and, in many countries of the region, they
are rapidly becoming a priority in public policy. In several countries,
the robust growth rates observed during the first half of 2004 did
not generate sufficient employment for the expanding labor force.
Significantly, in the many elections that have taken place so far
in the region in 2004, employment and income inequality issues were
major election themes that had a strong bearing on the election
results.
Finally, in recent years, and increasingly so, outbreaks of various
epidemics have become an integral part of regional risks. As the
outbreak of the SARS epidemic in 2003 showed, if such epidemics
are not detected early and dealt with promptly and openly at a regional
level, they can cause considerable damage to regional economies.
Had the SARS virus been more contagious, its economic impact would
have been dire. Earlier in 2004, a widespread regional outbreak
of avian flu also decimated the poultry industry in the region.
The recent occurrence of new avian flu cases in several countries
and subsequent reports that the H5N1 virus was found in pigs have
further heightened concerns about diseases that may jump from one
species to another, their possible impact on human health, and their
potential economic consequences.
The impact of an avian flu outbreak obviously depends on the scale,
duration, and spread of the disease. The macroeconomic impact will
be limited if the outbreak is confined to poultry as this industry
accounts for below 2% of GDP in most economies. Model simulations
show that, among the countries concerned, Thailand will be the most
hurt as poultry is an important export sector. But even with a half-year
ban on poultry exports, the impact on Thailand's GDP would be in
the order of 0.5 percentage points, and the impact on other Asian
economies minimal, in this model. Despite the relatively low macroeconomic
impact, some particular segments of society would be severely affected
though. Until any effective vaccination or other control method
becomes available, mass culling of poultry will remain the major
means of controlling the disease, which will hit farming incomes
and rural consumption hard in areas where poultry farming is concentrated.
Government compensation packages will be necessary both to offset
the income loss to farmers and to encourage early reporting.
Clearly, such measures will put pressure on government budget positions
in the short term. One element cannot be calculated at the moment
and that is the effect of the virus mutating and becoming transmissible
among humans. The health, economic, and social impacts would be
extremely severe as flu viruses are much more contagious, and possibly
more lethal, than the virus responsible for SARS. A pandemic could
then occur. Enhanced regional cooperation and openness in dealing
with possible large-scale epidemics, and significant improvements
in regional and national early warning systems and preparedness
plans, would then be of paramount importance to contain these multiple
impacts.
In conclusion, the risks are not negligible. However, the underlying
strong regional growth momentum could also create tremendous opportunities
if it can be channeled into improving regional competitiveness.
To this end, with regard to their long-term growth strategy, regional
governments should focus on enhancing resilience to external shocks
and on fostering domestic growth for greater sustainability. The
following considerations are germane in this respect.
First, broadening intraregional trade has enabled the regional
dynamics to allow more efficient resource allocation, thus helping
developing Asia's economies achieve more balanced growth. Second,
the emergence of strong regional domestic demand could provide extra
resilience to adverse shocks from the rest of the world. Third,
developing Asia's economies should continue structural reforms to
foster the investment climate through improving competitiveness
and productivity. These reforms include the successful implementation
of ongoing financial sector transformations--strengthening bank
balance sheets, broadening financial markets, establishing a sound
credit culture, and enhancing governance--and they remain key to
promoting domestic investment and attracting foreign investment.
These structural reforms remain particularly important, as sustained
progress in economic reforms would ensure resilient and balanced
growth in developing Asia to counterbalance an adverse external
environment. Fourth, the high oil prices that are likely to persist,
largely as a result of rising global demand, make it imperative
for developing Asia's economies to significantly improve their energy
efficiency levels. Indeed, their continued competitiveness may ultimately
hinge on this.
 Back
Foreword, Acronyms and Abbreviations, Definitions | Next
II. Economic Trends and Prospects in Developing Asia |
Publications 