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Asian Development Outlook 2004 : I. Developing Asia and the World
Prospects for the World Economy Prospects for Major Industrial Countries The recovery in industrial countries, which started at the end of 2001 stayed relatively weak in 2002, and remained subdued during the first half of 2003, but strengthened considerably over the last 2 quarters of the year, mainly in the United States (US), Japan, and the United Kingdom (UK); economic growth in the euro zone has been lagging (Figure 1.3). In spite of a significant upturn in growth, inflation has remained low in the US while deflation abated somewhat in Japan. In the euro zone, weak domestic demand and the appreciation of the euro have put downward pressure on prices. As a result, monetary policies continued to be highly accommodative in major industrial countries. Such a policy stance should continue for most of 2004 with a tightening of monetary policy and higher interest rates in industrial countries likely to start later in the year. 
Fiscal policies are expected to be neutral to moderately contractionary over the next 2 years. Although there are considerable imbalances and uncertainties in the world outlook, in particular with regard to employment creation in the US and the widening US fiscal and current account deficits, projections indicate robust growth in major industrial countries, largely due to a strong recovery in the US, for most of 2004, before some leveling off of growth in 2005 (Table 1.2).
United States. The US economy showed exceptional strength at the end of 2003 and in the first quarter of 2004, growing well above trend. A combination of factors resulted in exceptionally high A worrisome feature of the strong US recovery in the second half of 2003 was that it did not generate significant increases in employment. From August to December, average monthly employment gains turned out to be less than 56,000, well below historical figures during recovery periods. A range of factors provides some explanation for the jobless growth, including large gains in productivity, and the continued impact of overhiring at the end of the 1990s. Employment will be a key variable in the US economy in 2004-2005. Along with an improvement in the employment data in the first quarter of 2004, particularly in March, the fundamentals of the US economy appear to be strong, suggesting robust growth in 2004. The outlook for the business sector is very positive as new orders and order backlogs data show positive trends. The March Institute for Supply Manufacturing survey showed that the manufacturing sector continued to grow for the 10th consecutive month (Figure 1.5). Soaring profits due to declining unit labor costs and the fall With inflation projected to remain moderate and job creation still uncertain, the Federal Reserve is likely to keep its target Federal Funds rate of 1% unchanged until later in the year. Changes in core inflation will define the stance of monetary policy. Several factors are at play. First, sustained growth will not only start creating jobs, but also bring the economy closer to capacity, building up inflationary pressures. Second, the impact of the depreciation of the dollar should progressively be felt on domestic prices. Third, high projected oil and commodity prices will feed through and push up core inflation. Core inflation is therefore projected to accelerate during the second half of the year and into 2005, eventually leading to upward adjustments in interest rates. Projections of a further significant increase in the budget deficit for 2004 (to about $520 billion or 4.5% of GDP) will also put upward pressure on interest rates. Against a background of a tightening of macroeconomic policy taking hold only later in the year and of significant downside risks, the US economy is projected to expand at a rate of 4.2-4.7% in 2004. In 2005, both monetary and fiscal policies are forecast to be less accommodative. In the budget for fiscal 2005 (starting on 1 October 2004), most discretionary spending growth is expected to be contained. Interest rate increases will moderate growth in private consumption expenditures and residential real estate investment. Business investment should, however, continue to expand moderately. Some improvement can be expected in the current account deficit, thus contributing to growth. Projections are for GDP growth in the range of 3.2-3.7% in 2005. Japan. The economy of Japan turned out much stronger than anticipated in 2003, with GDP posting a 2.7% increase for the year as a whole. Growth in the last quarter of 2003 was a remarkable 7% on an annualized basis, the highest rate since the second quarter of 1990. The recovery was driven by a solid export performance (up 10% in real terms for the year as a whole) and a significant pickup in business investment. Private nonresidential investment contributed 1.5 percentage points to overall growth, and net exports a further 0.7 percentage point. Private consumption accounted for 0.6% of growth as consumer confidence remained weak through most of the year. At the end of 2003, employment started to respond modestly to the revival of economic activity, particularly in some large businesses. Unemployment declined slightly to 5.0% in February 2004. An improved employment situation will contribute to a progressive strengthening of consumer spending in 2004-2005. Such spending already strengthened significantly in the last quarter of 2003 and the first quarter of 2004, indicating that the recovery is broadening. There are also indications that deflation is easing, and this would further stimulate consumption spending. Despite some appreciation of the yen during the second half of 2003, exports have been buoyant, particularly to the PRC and the rest of Asia (Figure 1.7). A key factor affecting export growth will be the value of the yen, which appreciated against the dollar by 8.5% over the period January 2003 to March 2004. Intervention by the Bank of Japan moderated the appreciation: in January 2004 alone, it spent $67 billion to support the yen. At the end of Euro Zone. Euro zone GDP growth was a meager 0.4% in 2003. In the second quarter of the year, the euro zone economy actually shrank by 0.4% as private consumption, investment, and net exports all declined. The second half of the year saw some recovery as, in spite of the euro's appreciation, exports and business investment improved somewhat, particularly in France, Germany, and notably Spain where domestic demand is more robust. With few exceptions, corporate confidence improved in the latter part of the year. However, consumer confidence and demand remained very weak. GDP expanded by 1.2% (saar) in the fourth quarter. Constrained by the Stability and Growth Pact limit on budget deficits, fiscal policy was only mildly expansionary, but the three biggest euro zone economies-Germany, France, and Italy-breached the 3.0% deficit limit as a result of tax cuts. Despite inflation falling just below 2%, the European Central Bank (ECB) left its target rate unchanged at 2.0% since July 2003. Domestic demand thus did not benefit from additional monetary policy support. Furthermore, structural reforms to improve the competitiveness of the euro zone economies appear to have slowed during the course of 2003. By March 2004, the euro had appreciated against the US dollar by about 40% since February 2002, and the strength of the euro is increasingly a source of concern. In March 2004, the Ifo business climate index of manufacturing, construction, retailing, and wholesaling in Germany fell further to 95.4, after declining for the first time in 9 months to 96.4 in February. In contrast, the German purchasing managers' index (PMI), which measures future economic activity, improved somewhat to 54.1 points in March 2004 from 53.4 points in February. With limits to the squeeze on exports' profit margins, the strong euro could start dampening external demand, the main source of growth in the euro zone in 2003 and early 2004. This would affect employment prospects and further depress domestic demand. Inflation is projected to fall to the 1.5-1.7% range in 2004-2005, opening a welcome opportunity to loosen monetary policy and reduce interest rates. On the fiscal side, not much stimulus can be expected over the next 2 years as the economies exceeding the Stability and Growth Pact limit try to bring back their budget deficits to below 3.0%. On the positive side, in spite of the euro's appreciation over the past year, business confidence in France and Spain has been improving, as shown by several early 2004 PMI surveys. After 3 months of stagnation, the PMI for the euro zone rose in March. In Germany, there has been a pickup in investment in machinery and equipment, as well as in construction, while consumer confidence also appears to have improved. Hence, some modest strengthening of growth to 1.7-1.9% is projected for the euro zone in 2004, assuming no further significant appreciation of the euro. In 2005, GDP growth is projected in the 2.1-2.4% range, as domestic demand and exports contribute more evenly to growth. Within the EU, the UK economy offers a sharp contrast to that of the euro zone. It was on a rebound in 2003, expanding at an annual rate of 3.8% in the fourth quarter and 2.3% for the year as a whole. Domestic demand is providing a strong impetus to growth, particularly private and public consumption. For example, housing prices were up by 17% in February 2004 from a year earlier. In spite of a second rise in interest rates by 25 basis points to 4.0% in February 2004, domestic demand is seen as remaining robust in 2004-2005, even if some further interest rate rises can be expected later in the year and in 2005. Business confidence has also been rising as the world economy accelerates and stock markets remain fairly robust. Despite a substantial appreciation of the pound against the US dollar and lately against the euro, exports have been rising, with for instance exports to the PRC growing by more than 50% in 2003. Projections show the UK economy growing by 2.8-3.1% in 2004 and by 2.5-2.8% in 2005. World Trade and Commodity Prices Growth in world trade consistently strengthened throughout 2003, and remained strong in the beginning of 2004, growing at double-digit rates. According to World Bank estimates, world trade, as measured by world export volume, expanded by 4.7% in 2003, about 1 percentage point faster than in 2002. The trade performance resulted from a confluence of factors. First, trade between the rest of the world and Asia, as well as within Asia, boomed in 2003, led by the PRC and the other East Asian and Southeast Asian economies (Table 1.3). In the second half of 2003 and early 2004, shipments of electronics to and from nonregional economies as well as within the region increased rapidly. Exports from Japan, particularly to the PRC and the rest of developing Asia, surged in the second half of 2003, and exports from the US also picked up by the end of the year. The EU (with the exception of the UK) is the only region where exports have been lackluster. With robust growth projected for the world economy in 2004-2005, and developing Asia in particular, the strong performance of world trade in the first quarter of 2004 should translate in world trade volume growth of around 8-8.5% in 2004, slowing somewhat to about 6-7% by 2005.
Oil prices in 2003 were volatile and remained high throughout the year. The average price of $28.80 a barrel (Brent crude) in 2003 is well above forecasts earlier in the year. Supply uncertainties related to the Iraq conflict and unrest in Venezuela, low stock levels, increasing demand from the PRC (30% oil import growth in 2003), which has now become the second-largest oil importer in the world, as well as weather-related demand, have all helped keep oil prices high. By the end of 2003, the significant fall in the dollar also put upward pressure on oil producers to maintain local currency revenues. Oil prices stayed at above $30 a barrel during the first quarter of 2004 as the Organization of Petroleum Exporting Countries (OPEC) played an active role in managing the oil markets, as stocks remained critically low in major Organisation for Economic Co-operation and Development (OECD) markets, and as seasonal factors pushed up demand. Furthermore, OPEC announced a quota cut of 1 million barrels a day from 1 April to 23.5 million barrels a day, which will support prices during the second quarter in spite of a seasonal decline in demand. Higher non-OPEC production could, however, start putting some downward pressure on prices as 2004 progresses. Overall, given OPEC's apparent determination to support higher prices in the face of a weak US dollar, and robust demand in a strongly growing world economy-particularly the PRC, India, and other Asian countries-Brent crude oil prices are projected to stay relatively high in 2004 in a range of $28-30 a barrel, before easing somewhat to the $24-26 range in 2005 as demand and supply are better matched. Following a substantial decline in 2002, natural gas prices rose by nearly 30% in 2003; moderate increases are projected over the forecast horizon. The rally in prices of non-oil commodities, which started in 2002, strengthened considerably in 2003, with prices increasing by 13% over the year according to World Bank estimates. The combination of a weak dollar, a stronger world recovery, and soaring demand from the PRC for raw materials and base metals sent most commodity prices close to their mid-1990s peak. Speculative factors also contributed to the high prices in 2003 and early 2004. Demand from the PRC and falling world stocks led to a surge in metal and mineral prices by 28%. Raw materials, including cotton and rubber, rose by 16%, also largely due to strong demand from the PRC. Fertilizer prices rose by 15% over the year. Drought in producing countries led to a jump of 28% in prices for fats and oils while other agriculture prices rose moderately. Rice prices continued their rally, increasing by about 15% (Thai, 5% broken) between 2001 and 2003. After 3 years of decline, coffee prices rose slightly in 2003. Commodity prices are projected to remain generally strong in 2004 although the recent rates of price increases cannot be sustained for a number of items, particularly some agricultural commodities. In the first quarter of 2004, metal and mineral prices continued to soar with a quarter-on-quarter price increase of about 20%. Projections indicate a continued strong rally of metal and mineral prices this year, led to a large extent by demand from the PRC and the rest of developing Asia. Price increases should level off in 2005 as world demand slows and stocks are reconstituted. Forecasts from the Oxford Economic Forecasting model show metal prices rising by about 20% in 2004. The projections point to continued strong price gains for copper, lead, nickel, steel, tin, and zinc. Strong demand from the PRC, increasing demand from industrial countries, and low stock levels will positively impact on the prices of these commodities in 2004. Due to more rapid supply responses, agricultural prices are expected to continue their rally in 2004-2005 but at a much slower pace. However, agricultural raw materials prices-rubber and cotton in particular-are projected to show strong price gains in 2004 as world demand remains strong, but prices should level off in 2005, except perhaps for rubber. As supply improves, fats and oils prices (including palm and soybean oil) are projected to increase moderately in 2004, and decline somewhat in 2005. Among other main agricultural prices, forecasts for 2004 show stronger gains for rice prices and gains for coffee prices as markets for both commodities will be tight in 2004, before easing in 2005. Finally, the long-awaited revival of the electronics sector will lead to stronger dollar prices in 2004 for products such as DRAM chips, flash memory, and integrated circuits. Financial Market Developments Overall, inflation in the world economy, and in industrial countries in particular, remained historically low in 2003. OECD inflation (as measured by the GDP deflator) declined from 2.1% in 2002 to 1.8% in 2003, allowing monetary policies to remain accommodative throughout the year. Although relatively high oil prices have been creating upward pressures, overall consumer prices in the US rose by 1.7% (before seasonal adjustment) in the year to March 2004. Core inflation remains somewhat lower. In Japan, deflation is still apparent, although it has started moderating. In the euro zone, inflation recently abated to just under 2.0%. Hence, in major industrial countries, interest rates also remain exceptionally low. The US Federal Funds rate has stayed at a 46-year historically low rate of 1.0% since June 2003, while in the euro zone, the ECB rate was 2.0% over the same period. In Japan, the discount rate has been maintained at 0.1% since 2002. A few countries have, however, started to raise interest rates in 2003, notably Australia and the UK, which have been concerned by a possible bubble in asset prices-mainly in real estate-and high household indebtedness. Forecasts indicate inflation in OECD countries slowing somewhat in 2004 before picking up mildly in 2005. Euro zone inflation is, though, projected to decelerate over the next 2 years, possibly leading to a downward adjustment in ECB rates. In the US, a pickup in core inflation is likely during the second half of 2004 as higher oil prices and the depreciation of the dollar pass through the system and as growth remains robust. The response of the Federal Reserve to an increase in inflation will critically depend on the performance of the labor market. If strong growth does not create a significant number of new jobs, the Federal Reserve is likely to keep rates on hold. A progressive return to somewhat higher rates is likely only later in 2004 as core inflation picks up. The baseline assumption is for the Federal Funds rate to average 1.1-1.3% in 2004, increasing to 2.5-3.0% in 2005. The 6-month London interbank offered rate is projected to increase to about 1.6% in 2004 (from 1.1% in 2003). In contrast, the 6-month euro interbank offered rate is forecast to edge down to 2.0% in 2004 (from 2.3% in 2003). Corporate profits, which started to improve somewhat in 2002, mainly in the US, recovered sharply during the second half of the year, not only in the US but also in Japan, and to a lesser extent the EU. In the US, strong productivity growth continued to fuel corporate profitability. With corporate prospects improving and the uncertainties linked to the Iraq conflict abating, the US stock market recovered sharply from the second half of 2003; in Japan, the better outlook for the economy led to a surge in the Nikkei 225; while in the EU, some improvements in the prospects for many economies also translated into significant stock market gains. Despite some setback in the first quarter of 2004, stock markets in major industrial countries should remain relatively robust through 2004-2005 as the cycle moves toward its peak. The improved corporate profitability outlook combined with a revival in stock markets augurs well for capital spending in major industrial countries in 2004-2005. In emerging markets, continued low world interest rates and a strengthening world recovery also led to surging equity markets, particularly across developing Asia (Table 1.4). Prospects for regional equity markets in 2004-2005 remain upbeat, which will have a positive impact on business investment.
After hitting a 45-year low in June 2003 and after the Federal Reserve indicated that deflation was no longer likely, US bond prices fell and the yield on 10-year US treasury bills jumped by more than 100 basis points to 4.85% on 31 July 2003. At that time, there was serious concern that long-term interest rates would start to rise as growth accelerated in the US and expectations of huge US treasury financing requirements would influence market expectations. As it turned out, the recovery indeed gained momentum in the US but it was “jobless.” The lack of job creation appears to have dominated market The euro benchmark yield curve continues to show an inverted shape, sloping down at the short end as further rate cuts by the ECB are expected, before sloping up for maturities beyond 1 year (Figure 1.10). At the long end, rates rose in July 2003 but by only 40 basis points to 4.2%, and they have stayed virtually unchanged since then. Since the beginning of 2004, euro bond yields for 10-year maturities have been falling somewhat, indicating that the markets expect no major interest rate hike. Emerging markets have benefited from a long period of about 15 months of compression in sovereign risk spreads. Average spreads were 526 basis points in 2003, compared with 728 in 2002 (Figure 1.11). Developing member countries (DMCs) took advantage of these favorable conditions by issuing nearly $75 billion of bonds and notes in international capital markets in 2003, and by offering about $30 billion in According to Institute of International Finance data, net private capital flows to emerging markets rose to a 3-year high of $194.1 billion in 2003, up from $128.3 billion in 2002. Net private flows to developing Asia accounted for $116.7 billion, nearly double the amount of $66.3 billion in 2002. Half of this total ($58.3 billion) was financed by direct investment, much of it flowing to the PRC. An improving economic environment and rising corporate profitability led to a surge in portfolio inflows to developing Asia from $2.8 billion in 2002 to $29.4 billion in 2003. Bank and nonbank lending accounted for a further $29.0 billion, up from $6.7 billion in 2002. The prospects for private capital flows to developing Asia remain bright for 2004. The large foreign direct investment (FDI) commitments over the past few years, particularly in the PRC, should translate into continued strong growth in FDI inflows to the region. India and Thailand should also benefit from larger inflows of FDI in 2004. Estimates by the Institute of International Finance put total FDI inflows to the region at about $62 billion net, with about 85% going to the PRC. The region's stock markets will remain very attractive to investors, though inflows are likely to be somewhat lower than the high levels observed in 2003. In contrast, as yields move up and spreads widen for emerging markets, bond issues might be significantly lower than in 2003. The PRC might also take measures to discourage external borrowing.
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GDP growth of 8.2%, at a seasonally adjusted annualized rate (saar), in the third quarter of 2003. These factors included a surge in personal consumption expenditures resulting from the impact of tax refunds, a spike in residential and equipment (information processing hardware and software) fixed investment, and an improved export performance. Despite a slowdown of activity in the residential real estate market and a worsening trade balance, strong business investment spending maintained GDP growth of 4.1% in the fourth quarter of 2003, still above trend growth (Figure 1.4).
in the dollar-bolstering profits from overseas operations-should translate into significant increases in capital expenditures in 2004. In spite of weak gains in average earnings and the uncertain employment outlook, tax refunds in the first quarter of 2004 as well as continued low interest rates, and strong consumer credit growth (up by 8.6% saar in January 2004) should keep consumer spending buoyant at least during the first half of 2004 (Figure 1.6). While activity in the residential real estate market is projected to slow somewhat, net exports should start to support growth positively as the economy moves to the upward segment of the J-curve.
In real terms, exports to the PRC grew at annual rates of 35.5% in 2002 and 41.2% in 2003. In contrast, exports to the US actually declined in 2003, while they expanded moderately to the European Union (EU). The PRC now accounts for 12.2% of Japan's exports, just below the EU market share. A wide range of industries has benefited from surging exports to the PRC, including machinery and electrical machinery, metals, and precision instruments. The manufacturing export industries are expected to continue to expand strongly in 2004, mainly on account of robust regional export demand and rising shipments to the US. For example, industrial output increased by a solid 3.4% in January 2004 compared with the previous month.
March 2004, Japan's total foreign exchange reserves (including gold) stood at $826.6 billion. Despite deflationary forces still at work in some sectors, business confidence, as measured by the Tankan survey of business conditions, was at a decade high in the first quarter of 2004 (Figure 1.8). In the financial sector, substantial progress has also been made in reducing nonperforming loans (NPLs), which had fallen below 7% of bank loan portfolios at the end of 2003. Assuming that export growth remains on track, business investment continues to strengthen, and real consumer spending revives, the Japanese economy could return to a period of robust growth not seen in over a decade. Projections indicate that GDP is likely to grow by about 2.5-2.8% in 2004, and between 1.5-2.0% in 2005. However, deflation remains severe in some sectors, such as capital goods, and could continue to dampen nominal GDP growth. Finally, in addition to accelerating structural reforms, addressing longer-term issues such as the huge budget deficit and public debt will be required to sustain robust growth.
sentiment, moderating long-term (10-year) bond yields at around 4.5% since November 2003. At the short end of the market (up to 2 years), the US yield curve has steepened somewhat since the third quarter of 2003, as the market did not expect further rate cuts (Figure 1.9). At the long end (10 years), yields have remained virtually unchanged and even fallen somewhat since the end of the third quarter of 2003, reflecting market sentiment that interest rates will not be raised for some time. However, the reaction of the bond market to the Federal Reserve's January announcement that it will “be patient” on rate increases indicates that it could react fast (and furi
ously) to any hint of rate increases.
stock issues (
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