Catalog

	Table of Contents
p. 4 of 25 BACK | NEXT Foreword, Acronyms and Abbreviations, Definitions I. Developing Asia and the world Prospects for developing Asia, 2005 and 2006 Prospects for the world economy Risks Subregional trends and prospects II. Economic trends and prospects in developing Asia III. The challenge of higher oil prices Statistical appendix

Asian Development Outlook 2005 Update : I. Developing Asia and the world

---

Prospects for the world economy

A gradual slowdown in growth is now under way in the major industrial economies, following last year's rapid expansion. Growth has moderated due to rising oil and commodity prices, less accommodative macroeconomic policies, and, in some countries, an end to rapid house price inflation. The baseline assumptions in this Update for growth in the industrial countries are little changed from those of ADO 2005 (Table 1.2). However, based on data for the first half of the year, Japan is now expected to experience some improvement and the euro zone some further slowing (Figure 1.1).

At an aggregate level, growth prospects for industrial countries remain reasonably healthy, with projected expansion of 2.5% in both 2005 and 2006. Though lower than last year's 3.5%, this rate is slightly better than the past 5 years' average of 2.4%. For developing Asia, international trade and financial conditions remain favorable. The volume of world trade is expected to grow robustly, though not as fast as last year. Despite rising short-term US dollar interest rates, the region continues to attract capital inflows and pays premiums that are well below historical norms on funds raised in international markets.

Oil prices have risen substantially since the publication of ADO 2005 in April this year. The prices of benchmark Brent crude have already averaged $53/bbl in 2005 through 31 August. Prices continue to ratchet up on news of possible disruptions to supply. Even before Hurricane Katrina, tightness in the oil market was expected to continue through 2006, and possibly beyond (see Part 3).

The country chapters for this Update (in Part 2) were developed on a baseline assumption for oil prices of about $53/bbl in 2005 and $55 in 2006. But events have moved quickly and recent rises suggest that even these estimates may be too low and that oil prices could be sustained at higher levels. In real terms, however, oil prices are still some way off their peak levels. In first-half 2005 inflation-adjusted prices, monthly oil prices peaked at $107/bbl in November 1979. The yearly average price for 1979 was $83/bbl. Even if oil prices continue to climb, a replay of earlier crises is unlikely, primarily because the global economy is now considerably more oil efficient than before and is better able to cope with inflationary threats. But if oil prices continue to rise and persist at a level considerably above the baseline levels assumed in this Update, the outlook for growth of the international economy would be downgraded, with consequent knock-on effects for developing Asia.

United States

Brisk growth continues on the back of strong private consumption and a booming housing market. In the first half of 2005, growth was 3.6%, measured year on year (Table 1.3). Underpinning the broad-based economic expansion, the trade balance, which was a major drag on growth in the second half of 2004, also improved. Exports surged by 13.2% in the second quarter, at a seasonally adjusted annualized rate, building on a 7.5% increase in the first. Growth of import demand slumped, partly related to a large destocking of inventories. If business investment continues to pick up, helped by healthy corporate profits, imports will likely gain strength again, eliminating the net contribution of the external sector. Higher oil prices will also hoist the US import bill.

Strong consumer spending, reflecting high consumer confidence and buoyancy in the housing market, has been a major factor in the current expansion. But household finances are stretched and the household debt-service burden has soared to record highs. Although mortgage rates remain low, continued tightening by the Federal Reserve--in a context of a return to a neutral policy stance amid heightened inflation concerns--may now continue into 2006. This may eventually show up in higher longer-term interest rates and housing finance charges. An end to house price asset inflation would tell on private consumption and weaken growth. In such an environment, investment demand would probably feel the downdraft, too.

In summary, provided that oil prices do not jump further and the housing market cools gently, the overall outlook is mildly positive for the US economy. This Update's baseline GDP projection is 3.6% for 2005. A smaller fiscal stimulus, tighter monetary conditions, and a more sedate housing market are likely to mean that growth will edge closer toward its long-term trend rate of 3.3% in 2006. High oil prices could also help quell consumer spending.

It is too early to estimate the likely impacts of Hurricane Katrina. While the devastation and loss of lives were extreme, earlier experiences with natural disasters suggest that long-lasting effects on overall US growth are likely to be small, but oil supply disruptions could cause further spikes in prices and weaken confidence.

Japan

Following a mild recession in 2004, GDP grew by 1.3% (year on year) in the first half of the year (Table 1.3). Domestic demand has firmed up on both household and corporate fronts. Household income has expanded gradually and the unemployment rate has fallen to its lowest level since August 1998. This has helped support private consumption, which rose by 1.3% (year on year) in the first half. Business investment also rebounded, by 4.6% on the same period of the previous year. Capital spending may grow further if activity in the electronics sector recovers and this should encourage further labor hiring. Despite firm growth in the PRC and the US, Japan's major trading partners, continued export weakness has partly offset these positive developments. However, renewed inventory building in the second part of the year in the PRC and US may support a recovery in exports in the latter half of this year. Exports would also benefit from a pickup in the electronics cycle.

Given the better outlook for domestic demand and recovering exports, GDP is expected to grow at 1.6% in 2005. However, long-term potential growth is limited by Japan's aging population and lingering structural weaknesses. With its high level of energy efficiency, Japan may not be as badly affected as other regional economies by high oil prices.

Euro zone

The euro zone economy grew by 1.2% (year on year) in the first half of 2005 (Table 1.3). Although the economy is recovering from a cyclical low in the last quarter of 2004, the growth outlook remains bleak, as persistently high unemployment continues to erode consumer confidence and consumption demand. Following Germany, where domestic demand had already softened, France has seen consumer strength beginning to seep away, with household consumption contracting by 1.0% (on a seasonally adjusted annualized basis) in the second quarter, down from 3.2% growth in the previous 3 months.

Given weakening export growth and slack domestic demand, growth in euro zone GDP is projected to slow to 1.3% in 2005. In 2006, growth is expected to recover to 1.8%, closer to its potential rate. Although the impact of higher oil prices will also be felt in the euro zone, early signs of cyclical recovery are now apparent in some economies, including Italy and the Netherlands. Economic performance across the zone remains uneven making more difficult the task of monetary management. The European Central Bank seems likely to maintain its broadly neutral stance and keep its key policy rate at 2.0% for the remainder of the year. Neither is there much room for fiscal maneuver, due to continuing fiscal deficits that are over the Maastricht limits, and to large public debt and pension burdens.

World trade and commodity prices

Robust expansion in world trade continued into the first half of 2005, though with some pullback from the vigorous expansion of 2004. The downswing in the production cycle of high-technology industries has negatively affected industrial production and world trade. Recent monthly data on semiconductor orders, semiconductor sales, and chip prices have been volatile, first improving and then falling back toward the middle of the year. But the inventory cycle in electronics is short, and other leading indicators, such as equity prices for semiconductor manufacturers, suggest that recovery may come soon. Demand prospects for next year are also brightening, as global demand for information-technology products, such as wireless communications and consumer electronics products, gradually gains ground, particularly in the US.

After the run-up in the past couple of years, prices of nonenergy commodities stabilized in the first half of 2005 (Figure 1.2). This was a result of the moderating global demand and easier supply conditions. The prices of soft commodities (agricultural food and beverages) continued to fall on favorable harvests and increased supply. Prices of metals and minerals, though marginally declining in recent months, are expected to remain robust on the back of firm growth in Asia. Overall, nonenergy commodity prices are expected to register a modest gain of about 2-3%, before expanded supply and increased stocks peg back prices in 2006. Rising US dollar interest rates could also impact adversely on commodity prices.

Emerging market financial developments

Rising short-term US interest rates have barely registered in emerging financial markets. Emerging markets, particularly Asian equity and bond markets, are expected to continue to benefit from capital inflows in 2005 (Figure 1.3). After a brief retreat in mid-March and April, capital flows resumed by midyear, with equity portfolio investment showing particular strength. With low long-term US interest rates, credit spreads have also begun to narrow again.

Emerging markets' prospects for external financing conditions remain broadly favorable in 2005, given their robust economic growth and favorable macroeconomic conditions, but if long-term dollar rates begin to climb, as seems likely, these markets are likely to face more difficult circumstances moving through 2006.

Back Prospects for developing Asia, 2005 and 2006	Next Risks