Catalog

	Table of Contents
p. 6 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

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Subregional trends and prospects

Central Asia

The six Central Asian republics (CARs) will continue in 2005 with the rapid economic growth of recent years, on the basis of developments to midyear. Economic growth in the CARs as a group is estimated at 9.2% in 2005 (Figure 1.4), which is above the 8.7% projected in ADO 2005.

Emphasizing the importance of an expanding oil and gas sector, the pattern of growth divides the countries into two sets--those that are major hydrocarbon exporters and those that are not. The former group will perform better than the latter. Hence, Azerbaijan is projected to grow at 17.0% in 2005, Kazakhstan at 9.0%, and Turkmenistan at 10.0%. A combination of higher oil and gas prices, buoyant international energy demand, inflows of FDI, and investments in modern infrastructure has propelled rapid growth in these three countries. Growth there will be largely limited to the oil and gas sectors and to related sectors such as hotels, catering, and transport and communications.

The latter group--with lower per capita incomes--will turn in a less impressive performance, with growth in Tajikistan projected at 8%, Uzbekistan at 5% and in the Kyrgyz Republic at 3%. Political unrest resulted in the election of a new president by a strong majority in the Kyrgyz Republic; however, continuing economic uncertainty and weakness in gold production in the first half of the year is now expected to take growth below the 5% projected in ADO 2005. Favorable prices for non-oil export commodities (such as cotton, gold, aluminum, and other metals), expansion in the services sector, and economic reforms underlie growth in this group of CARs.

The medium-term outlook for the CARs as a whole is positive and points to strong GDP growth of 9.4% in 2006. This is above the forecast given in ADO 2005. In response to higher oil and gas prices as well as to increased production, the oil and gas exporting CARs will continue to witness rapid GDP growth, but likely with notable differences in growth trajectories.

A sharp acceleration in growth in Azerbaijan to 22.0% in 2006 is expected, related to the phasing-in of production from investments in its oil and gas fields and pipeline facilities as well as a booming construction sector. The country's economic expansion will be supported by continued large increases in FDI into the hydrocarbon sector.

Kazakhstan, the largest economy in the region, will see a mild softening of growth to 8.5% in 2006 in response to additional oil production building on a larger base and to real exchange rate appreciation damping manufacturing expansion. The Government will continue actively fostering economic diversification under the Innovative Industrial Development Strategy. In 2006 it plans to allocate more resources to the development of industrial clusters in food, textiles, machinery, metallurgy, construction materials, and tourism. Furthermore, it has approved an expansionary medium-term fiscal policy for 2006-2008 in which the general budget deficit target (excluding the National Fund which saves part of oil revenues) has been raised to nearly 2% of GDP.

Risks for these two countries include continuing political unrest in Azerbaijan and possible disruptions in Kazakhstan in the lead-up to an expected presidential election in December 2005.

In Turkmenistan, GDP growth is projected to moderate to 7.0% in 2006. This large natural gas producer's economic outlook is closely linked to long-term export contracts with the Russian Federation and Ukraine and to the need for structural reforms to stimulate private sector development.

The other three CARs will see more moderate growth in 2006. The outlook for the Kyrgyz Republic is for a mild economic recovery (projected growth at 5.0%) with the expected maintenance of political stability by the new administration and the continuation of a pro-growth economic program that has been supported by increased foreign aid in recent years.

In Uzbekistan, the prospects are for a small improvement in growth to 6.0% in 2006. Growth will be supported by increased investment from the PRC in the country's natural gas sector and the expected implementation of measures to revitalize the private sector (including simplified taxation, stronger legal protection, and improved access to industrial finance through banking sector liberalization). In an economic environment of stringent state control and regulation, however, it will take time for these measures to feed through into a private sector response. Heightened political tensions could be a risk to the economic outlook.

Tajikistan is projected to see a slowdown in growth to 7.0% in 2006. This is explained by a tapering off of growth due to capacity limits on the expansion in the country's two main economic activities (export of cotton and aluminum production), a large farm debt overhang in the cotton sector, and a weak response from the nascent private sector.

Inflation in the six CARs will increase in 2005 from both the actual level in 2004 (6.0%) and the ADO 2005 projected level, to 7.4%. Azerbaijan will experience the highest rate at 10.0% and the Kyrgyz Republic the lowest of 4.6%. The remaining four CARs will see inflation of around 7.0%. Nevertheless, with the possible exception of Azerbaijan, inflation in the CARs in 2005 will remain within manageable levels. In the oil and gas exporting economies, higher inflation is symptomatic of a tendency for overheating in the wake of resource windfalls, and, together with upward pressures on the nominal exchange rate, has resulted in appreciation of the real exchange rate in Azerbaijan and Kazakhstan. This is likely to erode the price competitiveness of domestic producers in both these economies, but particularly in Azerbaijan, which has the more fragile manufacturing base. These are classic early signs of "Dutch disease" that seems to characterize many natural resource-based economies and is a challenge to their policy makers.

Inflationary pressures in the CARs are also partly associated with expansion in investment and consumer demand. Cost-push impulses arising from strong growth in public sector wages, and in prices of producer goods and utilities have also played a role. Public sector wage increases have been significant in the hydrocarbon-exporting CARs--Kazakhstan, for instance, awarded a 32% public sector wage increase in July 2005. In the non-oil CARS, wage increases have also been sizable but have often been made in the context of efforts to improve productivity in the public sector.

Over time, however, inflationary pressures in the CARs are expected to ease as the authorities exert greater control over the money supply and, more important, over expectations for public sector wages. Aggregate inflation is expected to fall to 6.6% in 2006 and the variation between the individual countries is expected to narrow, though the oil and gas exporters will have somewhat higher inflation than the other three countries.

The current account deficit of four of the CARs (as no projections are made for Turkmenistan and Uzbekistan) will continue in 2005 but at an estimated 1.7% of GDP, substantially less than the ADO 2005 projection of a 3.2% deficit for these four countries. This revision is largely due to Kazakhstan, with an estimated current account surplus increased from 1.0% to 3.0% of GDP in 2005. Higher oil, gas, and commodity prices, along with increased production, have led to export earnings in the CARs exceeding expectations, but they have been offset by higher consumer and capital goods imports and larger deficits on invisibles (oil sector payments for services, profit outflows, and labor remittances). The current account deficit in Azerbaijan has been covered by foreign investment, and in the other CARs by foreign aid.

The current account position for the four CARs as a whole is expected to improve in the medium term with their deficit projected to disappear in 2006 and perhaps even turn into a larger surplus in 2007. Underpinning this improvement are expectations of significant increases in oil exports from Azerbaijan and Kazakhstan. There are also likely to be some increases in manufactured exports (e.g., metal products and chemicals) from Kazakhstan as cluster development under the Innovative Industrial Development Strategy begins to take effect.

Current account deficits are expected to continue in the Kyrgyz Republic and Tajikistan, reflecting a combination of moderate performance in commodity exports and sustained demand for imports. Imports will continue to be buttressed by development assistance and by some increase in FDI as the countries implement economic and structural reform programs that are designed to raise growth rates and reduce poverty.

East Asia

The economies of East Asia are projected to grow in aggregate by 6.9% in 2005 (Figure 1.5), in line with their strong average expansion rate of the past 5 years. This will represent a slowdown of nearly 1 percentage point from the high growth rate of 2004. All five economies are expected to decelerate.

The overall 2005 projection for East Asia in this Update is little changed from ADO 2005, but this hides some significant revisions within the subregion: the growth forecast for the PRC, by far the largest economy, is revised up, while forecasts for Hong Kong, China; Republic of Korea; and Taipei,China are lowered. The estimate for Mongolia is unchanged from ADO 2005.

In 2006, subregional growth is projected to remain at around the 2005 level. The PRC will slow a little (by an estimated 0.4 percentage point) as will Hong Kong, China and Mongolia. Korea's economy is expected to rebound (by 1 percentage point), as is Taipei,China's.

This year in the PRC, a surge in net exports and--despite government efforts--stubbornly high growth in investment resulted in stronger than expected 9.5% growth in the first half, the same rapid pace recorded in the whole of 2004. Exports continued to power ahead, by 32% in the first 7 months of the year, a rate much stronger than in other subregional economies. One reason was a surge in textile exports in the first quarter, after the abolition of textile quotas under the Multifibre Arrangement. Another was the continued buildup of highly competitive manufacturing capacity in the PRC, supported by strong foreign and domestic investment and by the PRC's 2001 entry into the World Trade Organization.

In addition, an excess supply of some products on the domestic market, such as steel, was diverted abroad, which further raised exports. Finally, price controls on domestic energy led to a rise in exports of products such as gasoline and naphtha in the first half as oil companies sought the much higher prices paid for energy outside the PRC.

Import growth, in contrast, slowed to 14% in the first 7 months, from about 35% over the previous 2 years. The imports that were most affected included agricultural and mineral products, base metals, machinery, and motor vehicles. A slight slowdown in investment in fixed assets was behind the deceleration in some imports, such as machinery. Other reasons for reduced imports included a better domestic harvest and a drawdown on oil inventories. The buildup in manufacturing capacity also appears to have contributed, as the economy now has the capacity to make products, in industries such as electronics, that it previously imported. Expectations of a currency appreciation also played a role, as some companies brought forward exports and delayed imports.

The result of these diverging trends--rising exports and decelerating imports--was a record first-half trade surplus of nearly $40 billion. Increasing concern among industrial trading partners led to agreements to limit PRC textile exports.

Another strut for growth was investment in fixed assets. The Government has been taking steps since September 2003 to rein in investment in industries it considered to be overheated, such as steel, automobiles, and real estate. This effort started to have an impact in the first half of 2005. However, investment still rose by more than 25%, down just 3 percentage points from a year earlier. In the second half, investment is expected to slow further as administrative steps gain traction. Tighter credit and moderation in profit growth will also curb investment appetites.

Reflecting the strong performance in the first half, the PRC GDP growth forecast is upgraded to 9.2%, from 8.5% in ADO 2005. In 2006, growth is expected to soften to a still-robust 8.8%, a touch higher than forecast in ADO 2005. Investment expansion will likely ease further on moderate credit expansion and deteriorating profitability. External demand will ease as global trade growth slows and as a result of recent steps to constrain exports of energy-intensive products, such as aluminum and steel. The decision in July to manage the exchange rate based on market forces, with reference to a basket of currencies, and to revalue the yuan by 2.1% against the US dollar could have a moderating effect on export growth and on investment in export industries. It should also improve the terms of trade and help constrain any inflationary pressures.

This year's strong trade performance has led to an increase in the forecast for the PRC's current account surplus to 4.7% of GDP in 2005 and 3.6% in 2006. Inflationary pressures in the PRC, and indeed in most of East Asia, have been lower than expected this year. A better harvest and excess capacity of many consumer products explain the PRC's forecast 2.5% inflation rate for all of 2005, down more than a percentage point from 2004 and lower than expected previously. The forecast for 2006 is for a similar inflation rate.

Korea, the second-largest economy in East Asia, posted growth of 3.0% in the first half of 2005, well below the 4.6% rate for the whole of 2004. Its export growth rate in US dollars fell to 11%, from 38% in the year-earlier half. As a major producer of electronic products, Korea has followed the global electronics cycle, benefiting from a strong upswing in 2004, then suffering from the downswing in the first half of 2005. The drop in Korea's export growth also reflects to some degree the slowdown in the PRC's imports, because the PRC buys capital equipment, steel, and other industrial materials from Korea.

The growth rate of imports into Korea slowed in the first half, to 15% from 26% a year earlier. (This slowdown would have been sharper except for higher prices paid for imported oil and other energy.) The trade surplus fell by 18% to $12.5 billion and the contribution of net exports to GDP growth is expected to decline in the full year.

Domestic demand in Korea has picked up from the prolonged slump in consumption caused by the 2003 credit card crisis, when household debt exceeded 70% of GDP and about 8% of the population were delinquent on credit card payments. By mid-2005, private consumption had increased consecutively in 4 quarters. However, corporate investment remained weak because of the slowdown in exports, high global oil prices, and a stronger local currency. This Update lowers the 2005 forecast growth rate for Korea by a half percentage point to 3.6%, nearly 2 percentage points below the average for the past 5 years.

In 2006, Korea's growth rate is projected to rebound by 1 percentage point to 4.6%, influenced by the expected upturn in the global electronics cycle. Domestic demand will continue to recover, but at a modest pace. Lackluster job creation and planned new taxes will weigh on consumption growth, and new property regulations and taxes are likely to damp investment in housing.

The first-half slowdown was even more abrupt in Taipei,China, which recorded growth of 2.8%, or half the growth rate experienced in 2004. This economy, also dependent on global electronics demand, saw its export growth rate, measured in US dollars, plunge to 7% in the first half of 2005, from 26% in the year-earlier period. The relocation over recent years of some electronics production to the PRC, where labor costs are lower, has reduced Taipei,China's export capacity while lifting exports from the mainland. Import growth fell sharply, too, although high oil prices tempered that decline to 11%. The trade surplus dwindled in the first half and the authorities have warned that the full-year surplus could be the lowest since 1981. Net exports will barely contribute to GDP growth.

As in Korea, private consumption has picked up a little, supported by a recovery in the property market, rising incomes, and employment growth. Private investment is expected to slow a little during the year but public investment in infrastructure is forecast to increase. The growth forecast for 2005 is lowered by a half percentage point to 3.7%, which is just above the economy's 5-year average. For 2006, growth is expected to pick up by 0.4 percentage point to 4.1%, slightly below that predicted in ADO 2005.

Taipei,China's current account surplus is seen easing to 4.8% of GDP in 2005 and 4.6% in 2006, lower than previously expected, as high oil prices bring down the trade surplus. Inflation is likely to stay at around 1.6%, constrained by more competition in the economy since it joined the World Trade Organization, increases in the official discount rate this year, and an expected slight appreciation of the currency.

Hong Kong, China grew by 6.5% in the first half of 2005, compared with 8.1% in all of 2004. Its export growth eased to 12% from about 15% in the year-earlier period. This comparatively stronger export result was attributed to the economy's close integration with the rapidly developing Pearl River Delta, and to strong growth in reexports originating in the mainland. Growth of imports slowed to 9% in the first half from 19% a year earlier, and the trade deficit narrowed. Services exports, a major earner for the economy, grew strongly. Net exports are expected to contribute to growth in 2005. Consumption and investment have held up, reflecting gradual growth in employment and wages, and firmer asset markets. Share prices reached their highest levels in more than 4 years in August, and property prices have rebounded about 70% since the housing market bottomed out in August 2003.

The forecast for Hong Kong, China's growth in 2005 is trimmed by 0.3 percentage point to 5.4%. Second-half economic activity will be damped by interest rate increases over recent months and by the expected cooling in the PRC. For 2006, these factors will remain in place, such that growth is expected to moderate to 4.3%. The current account surplus will decline from the high levels of the past 2 years, but still exceed 7% of GDP this year and next. Inflation is forecast at 1.2% in 2005, rising to 2.2% in 2006.

Mongolia, the least-developed economy in the subregion, is expected to grow at 7.0% this year, an unchanged forecast from ADO 2005. Data for industrial production, mining, and trade suggest robust growth in the first few months of this year. A relatively mild winter and good summer rains augur well for agriculture. However, inflation has spurted and the full-year forecast for prices is revised up to 10.0%.

The projections for East Asia's economies, which are increasingly linked to the PRC, are vulnerable to changes in that large economy's performance. While the PRC has expanded by 7.5-9.5% annually over the past 5 years and looks set to stay at the top end of this range over the next 2 years, there are downside risks that center on banking system weaknesses, energy bottlenecks, and overcapacity in certain industries.

South Asia

The economies in South Asia continue to prosper. Regional GDP growth in this Update is projected at 6.8% for 2005 and 6.6% in 2006 (Figure 1.6), or slightly better than the performance expected in ADO 2005. This revision rests largely on upward adjustments for Pakistan in 2005 and India in 2006. The region as a whole is benefiting from its further integration into an expanding global economy, rising consumer spending, generally accommodative monetary policies, and continued market liberalization policies that foster business activity and investment.

Inflation for the region is now projected to be about a half point higher than in ADO 2005 at 5.5% in 2005 and 4.1% in 2006. Pressure on prices, however, has been eased by a limited pass-through of the large increase in international crude oil prices to the prices of domestic oil products. Political reluctance to raise domestic prices appreciably has been made possible mainly by state-owned refiners and distributors taking large losses and also by budget subsidies and cuts in oil product taxation. Financial pressures from losses are growing, though, and securing price adjustments in this sensitive area while avoiding abrupt impacts on prices and output is a crucial task for most country policy makers in the period ahead.

Projections for the aggregate current account deficit in South Asia have been raised by up to 0.5 percentage point of GDP to 1.5% in 2005 and 2.0% in 2006. Export growth in this period is expected to moderate from 2004 rates but still stay robust. The envisaged downside for some countries from loss of garment quotas applicable under the Multifibre Arrangement has not yet been seen in the subregion. Indeed, data for the first 5 months of 2005 in the important US market show Bangladesh, India, Pakistan, and Sri Lanka with double-digit expansion in apparel/knitwear imports on the same period a year earlier, while many other supplying countries recorded declines.

The outlook for India (accounting for about four fifths of the subregion's GDP) is for GDP growth of 6.9% in FY2005 and 6.8% in FY2006. Recently the Government announced the Bharat Nirman (Building India) program, which will spend Rs1,740 billion (US$40 billion, equivalent to 5% of FY2005 GDP) in six critical areas of rural infrastructure investment over the next 4 years. This initiative upgrades growth prospects for FY2006, and adds to the continuing underlying forces for a positive outlook, including an acceleration in private investment activity, a rise in consumerism by a growing middle class, a more aggressive competitive financial sector, a record of business opportunities demonstrated in export sales, and the continuing impact of market liberalization policies.

Inflation was a moderate 4.1% in mid-2005 and monetary growth was within the Reserve Bank of India target. Projected inflation in this Update has edged up to 4.8% for FY2005 and 3.3% in FY2006, though the outlook is clouded by uncertainty stemming from the very limited adjustment of domestic oil product prices to higher global oil prices over the past two fiscal years and into FY2005. This divergence has been financed mainly by losses of state-owned oil marketing companies. Such losses for FY2005 are estimated at 1.1% of GDP (up from 0.6% in FY2004) in the absence of further price adjustments.

Pakistan's GDP growth at 8.4% in FY2005 (ended 30 June 2005) exceeded expectations, with output in manufacturing and agriculture surprising on the upside. Favorable weather and expanded availability of credit and fertilizer boosted agricultural growth to 7.5%, a 9-year high. Growth was underpinned by strong domestic demand fueled by record growth in private credit, higher farm incomes, and stronger inflows of workers' remittances. Mainly reflecting demand conditions but aggravated by food shortages, average CPI inflation jumped to 9.3%, the highest rate in 8 years. Robust growth and higher oil prices pushed imports up by 38.1% and, though export growth was robust at 16%, the trade deficit widened sharply to $4.5 billion. Remittances and official transfers held the current account deficit to $1.5 billion, or 1.4% of GDP.

Sound macroeconomic fundamentals, enhanced private investment, and a significant expansion in the public sector development program will bolster Pakistan's economy in FY2006, though their positive impact is expected to be diminished by the increase in global oil prices. The net result is that the economy is now projected to grow by 6.5%, i.e., 0.5 percentage point lower than forecast in ADO 2005. Having peaked in FY2005, inflation is expected to decline somewhat to 8.5% during FY2006, in response to monetary tightening and the opening up to imports of essential food items from India. However, a large monetary overhang, higher world oil prices, and an expansionary fiscal policy will make it difficult to contain price increases.

While price adjustments have been made, high oil prices are likely to have a negative fiscal impact of about PRs30 billion (0.4% of GDP) in the form of revenue loss due to lower petroleum surcharges and additional subsidies to oil marketing companies and refineries. Moreover, large rises projected in development spending and in government servants' salaries and pensions will contribute to a higher fiscal deficit in FY2006, though it will remain below 4.0% of GDP.

Imports are forecast to grow at about 18% in FY2006 because of continuing fast economic growth and a steeper oil bill, while exports are expected to grow by about 15%, benefiting from liberal incentives for export industries announced in the FY2006 budget and the ending of textile quotas at the start of 2005. Expansion of the trade deficit and higher shipping charges point to the current account deficit widening to about $3.5 billion, or 2.8% of GDP, though financing is not expected to present a problem because of anticipated substantially larger privatization-related FDI in FY2006.

In Bangladesh, GDP growth for FY2005 (ended June 2005) slowed to 5.4%, mainly reflecting the adverse impact of devastating flooding in July-September 2004. Inflation picked up to 6.5% due to higher food prices, and, amplified by a 4% depreciation of the taka, higher prices for commodity imports. Imports grew rapidly (up 20.6%), reflecting a 54% jump in the oil import bill (to $1.5 billion) and a strong rise in non-oil imports. Although exports and workers' remittances grew rapidly, the current account position moved to a deficit of 0.9% of GDP in FY2005 from a 0.2% surplus a year earlier. The jump in the oil import bill caused much larger losses (estimated at $445 million, equivalent to 0.7% of GDP in FY2005) at the state-owned Bangladesh Petroleum Corporation as the Government has allowed very little adjustment in domestic prices for oil products. The losses have been entirely financed by domestic and foreign borrowing. Policy in the year ahead will need to grapple with an even higher oil bill and the appropriate means for greater price adjustment. A reduction in oil taxation in the FY2006 budget will help stem oil company losses but will place further pressure on revenue mobilization to continue to meet budget deficit targets.

The outlook is for GDP growth to stay level at 5.5% in FY2006, a half point lower than the ADO 2005 projection. Growth will be aided by recovery in agriculture but some moderation in production and export of garments is expected as global competition becomes more intense. More generally, the outlook points to the need to tighten monetary policy, both to keep a lid on market pressures on the exchange rate as the current account deficit widens and to contain inflation, and this will restrain growth. Although both import and export growth is forecast to slow, the current account deficit for FY2006 is now projected at 1.7% of GDP, 0.7 points larger than in ADO 2005. Inflation is expected to be contained at 6.0%.

For Sri Lanka, this Update edges projected GDP growth down to 5.1% in 2005 and 5.5% in 2006, slightly lower than in ADO 2005, but even then the medium-term outlook for a solid aid-assisted recovery from the December 2004 tsunami (Box 1.3) is essentially unchanged from that April forecast. The central bank again raised policy rates in May and June and price pressures have eased such that CPI inflation (year on year) fell from 14.1% in March to 9.4% in June. This Update adjusts projected inflation in 2006 to 7.1%, from 9.0%.

Changes in oil product prices have been made but subsidies of about 1% of GDP remain, adding to budget strains. While the major risk remains uncertainty over the cease-fire and peace process with the Liberation Tigers of Tamil Eelam (Tamil Tigers), fissures in the Government's parliamentary coalition over reaching an aid-sharing arrangement with the Tamil Tigers and the August decision of the Supreme Court requiring a presidential election in 2005 (to be held between 22 October and 22 November) add greater political risk to the economic outlook.

The outlook for the Maldives is unchanged--1.0% growth in 2005 and a sharp recovery in 2006 at 9.0%. Data through July 2005 show tourist arrivals steadily recovering from the shock of the tsunami, continued price stability, and a balance-of-payments current account deficit being financed without loss in foreign exchange reserves.

This Update raises Afghanistan's projected GDP growth from 11.3% to 13.6% in FY2005 (ended 20 March 2006) on the basis of an apparent rebound in agricultural production. The 10.0% expansion for FY2006 projected in ADO 2005 is maintained. Year-on-year inflation declined to 11.5% in June 2005 (from 16.3% at the end of FY2004) and is expected to moderate to 10.0% by end-FY2005, according to the IMF staff-monitored program. The Government continues to implement sound macroeconomic policies and structural reforms in the context of a difficult security environment.

Bhutan's outlook for GDP growth at 8.0% in FY2005 (ended June 2005) and FY2006 is maintained. National accounts estimates were recently rebased to 2000 prices and, with more weight given to the power sector, outcomes on this new basis could be higher. The medium-term outlook continues to be favorable because of development of new luxury resorts for high-end tourism and export revenue from the startup of the 1-gigawatt Tala hydroelectric project.

In Nepal, GDP growth for FY2005 (ended mid-July 2005) was only 2.0% (against an ADO 2005 projection of 3.0%) owing to the impact of the insurgency and political instability on the economy generally. For FY2006, this Update marks down growth to 3.0%. Although tourism remained weak in FY2005, the current account surplus increased substantially to 3.5% of GDP as imports were subdued and workers' remittances remained buoyant.

Inflation was at 4.5% in Nepal, but it is likely to pick up to 5.0% in FY2006. This reflects higher petroleum prices, a hike in the value-added tax rate, and an increase in civil servants' allowances. Foreign exchange reserves are ample and the peg to the Indian rupee should continue to cap inflation, unless prolonged supply disruptions materialize.

Box 1.3 Restoring local economies after the tsunami The Indian Ocean tsunami last December devastated coastal areas in Indonesia, India, Sri Lanka, Maldives, and Thailand, destroying families and communities, houses, fishing boats, farms, and other assets, and dragging at least 2 million people into poverty (Asian Development Outlook 2005). In the 8 months since then, significant financial resources have been directed at providing initial relief and on starting to restore local economies. There has been a stronger focus on generating work and involving the communities than in past disaster-recovery programs. In Aceh, Indonesia, where an estimated 600,000-800,000 jobs were lost because of the tsunami, up to 35,000 people are employed in clean-up operations. In Sri Lanka, 87% of households in the affected areas suffered the loss of their main income. Now, 60% of these households have regained some source of income, mainly through temporary manual labor programs. These programs not only provide income but also help address the psychological trauma as people take an active part in the recovery and rebuilding of their communities. Overall, the initial relief operations appear to have succeeded. The recovery effort is now moving to the medium- to long-term process of reconstruction--from cash-for-work programs to restoring local economies, since clearly, such programs alone will not restore sustainable livelihoods. However, restoring local economies will take much longer in some places than others. Recovery: Fast or slow track? In an examination of the impact of the tsunami on poverty, ADO 2005 described two scenarios of recovery--fast and slow. Under the fast-recovery scenario, assumed to take 2-3 years in most of the countries, poverty caused by the tsunami would be eliminated by 2007 in all countries except Indonesia, where the additional number of poor would still be around 345,000 that year (Box table). If the recovery process took longer--4 to 5 years (the slow-recovery scenario)--the additional number of poor would be 1.1 million in 2007. So far, the record among the countries is uneven. Thailand has restored many of its coastal resorts and is waiting for tourists to return in large numbers. Likewise, most of the resorts in the Maldives are back in operation, and the industry hopes to see a complete rebound by the end of 2006, about 2 years after the tsunami. As of July, tourist arrivals were about 70% of last year's level. The tsunami caused much more damage in Indonesia, Sri Lanka, and India, so these countries face greater problems with the management of reconstruction programs. There are also political impediments to recovery in Indonesia and Sri Lanka, where rebel groups control parts of the tsunami-affected areas. Progress in Indonesia was initially slow because of the time it took to establish the Rehabilitation and Reconstruction Agency, which will play a central role in managing recovery programs. Now that the agency is in place, and a peace agreement has been reached between the Government and separatist rebels in Aceh, the reconstruction process is expected to accelerate. If the agency functions as expected, Aceh may be rebuilt in 4 years. In Sri Lanka, it took some time for the Government to agree on establishing a system to distribute aid in areas controlled by the Liberation Tigers of Tamil Eelam, and there are still disputes over involving this group in the reconstruction. As a result, recovery has been hindered. In the absence of a durable agreement between the Government and rebel groups, it would be premature to conjecture when reconstruction might be completed. India is focusing on restoring the fishing industry, housing, infrastructure, and rural livelihoods in mainland states. Thousands of fishing boats are working again; electricity, water, and transportation links are coming back into operation; and livelihood programs are being undertaken through self-help groups. However, the full reconstruction program is still in preparation, with land acquisition, development planning, and engineering design requiring more time. More attention is needed on these preparations, as it is on the Andaman and Nicobar islands, so that the overall recovery in India's affected areas is speeded up. It appears that the fitful progress on recovery achieved so far in the five countries may well mean that the additional number of poor in 2007 could exceed 600,000. Challenges In addition to the issues outlined above, three other main challenges need to be addressed to speed recovery and ensure that the disadvantaged are not left behind in the rebuilding effort. These emanate in large measure from difficulties in restoring the informal economies of the affected areas, and from problems in reestablishing property rights. First, relief programs, even relatively successful ones, leave gaps in their coverage. Priority is often given to people who are registered with the authorities, such as owners of businesses. Registered fishing communities are more likely to receive assistance for rebuilding or buying new boats than those in more isolated areas and without licenses. Farm workers, small-scale traders, casual laborers, and others in the informal economy tend to be left out, too. Second, land-ownership issues remain a serious problem for many people trying to rebuild. In some cases, ownership was recorded only in the name of a family member killed in the tsunami. For others, all copies of records were destroyed. And the very shape of some coastal areas was changed by the huge waves that washed away land. Third, other problems have arisen. Bouts of localized inflation and contraction in banking credit have aggravated the suffering in some tsunami-hit regions. Inflation in Aceh, for example, is running at 17%, or more than double the national rate, mainly due to demand pressures created by the presence of aid agencies and the reconstruction work getting under way. Banks have faced difficulties in assessing credit risks when records have been lost and collateral destroyed. Building up local economies from scratch is an enormous undertaking. It requires investment in infrastructure; the creation of jobs and support for sustainable livelihoods; and efforts to put back together the institutional and informational fabric that supports commercial activity. Progress is obviously being made--but at different speeds in different places. Although the macroeconomic impact of the tsunami is limited, its impact will endure in the affected localities, with the additional number of poor still at a high level in 2007. Minimizing economic hardships will require greater efforts to address the bottlenecks to recovery and to ensure that the assistance covers those who are being bypassed.

Southeast Asia

Growth slowed in much of Southeast Asia during the first half of 2005, as was expected in April's ADO 2005. For the whole year, subregional GDP is forecast to expand by a fairly robust 5.0% (Figure 1.7), but revised down by 0.4 percentage point from ADO 2005. Expectations for growth in 2005 are reduced for Malaysia, Philippines, Singapore, and Thailand, and these countries will also record much lower growth in 2005 than 2004 (by more than 2 percentage points on average). Conversely, this Update's forecasts for Cambodia, Indonesia, and Lao People's Democratic Republic (Lao PDR) are revised up, while the projection for Viet Nam is unchanged.

Various factors have conspired to bring down growth in Malaysia, Philippines, Singapore, and Thailand.

Slower growth of world trade, especially in demand for electronic products, has crimped the expansion of exports. Export growth in Singapore (in US dollar terms) fell by about half to 10% in January-June 2005 from 21% a year earlier. The Philippines suffered as well: export growth tumbled to about 3% from nearly 9% over the same period. Malaysia and Thailand also recorded sharp decelerations.

Import growth, too, softened. In the Philippines, imports actually fell by 1.5% in the first half, year on year, and in Malaysia import growth slowed to 9.0% from 28.0% a year earlier. In both countries, the demand for imported intermediate goods was hit by weakening export growth. In Thailand, however, the higher cost of imported oil, when combined with an increase in imports of other items, sustained import growth in the first half of 2005 at about the same pace as in the year-earlier period.

Higher global oil prices have also been a drag on growth in some countries. Due to their dependence on oil imports and the oil intensity of their energy consumption, Philippines, Singapore, and Thailand are particularly susceptible to the negative effects of higher oil prices. Even Malaysia, which is a net oil exporter, feels the downdraft of higher oil prices through their impact on demand for its manufactured products from major trading partners (see Part 3).

Ill luck has also played a role. In early 2005, bad weather reduced agricultural production in the Philippines and Thailand. In the Philippines, agriculture was hit by a drought in early 2005. In Thailand, a prolonged drought lasted through the first half of the year. A new outbreak of avian flu also affected the country, which is a significant exporter of poultry. Finally, tourist arrivals in Thailand fell early in the year because of the tsunami disaster of last December.

Policy conditions have been less expansionary. In Malaysia, Philippines, and Singapore the fiscal contribution to growth has been reduced. Malaysia recorded a fiscal surplus in the first quarter after expenditure shortfalls. Monetary conditions have been tightened in the Philippines and Thailand, with interest rates being raised from low levels. Singapore has maintained its policy of allowing a gradual appreciation of its currency.

Among the economies to report stronger growth in the first half of 2005, different factors have been at play.

Viet Nam stands out with growth of 7.6%, the highest first-half rate in 5 years. Both consumption and investment were robust. As a net oil exporter, the economy also benefited from higher prices for its crude oil shipments. Export growth remained rapid, although import growth was even faster because of strong domestic demand and higher prices for imported items such as petroleum products, fertilizer, and steel. The forecast for full-year growth is 7.6%, unchanged from ADO 2005, putting this year's expansion rate slightly above the 2004 level.

Indonesia also improved its performance in the first half of 2005, expanding by 5.9%, or 1.5 percentage points faster than the year-earlier period. This reflected a pickup in investment from a low base following the smooth transition to a new administration in late 2004 and expectations of greater regulatory certainty and a recovery in infrastructure spending. Indonesia recorded strong growth in trade--partly because of its large two-way trade in oil--and a higher trade surplus. The second half presents serious challenges, however. If the Government keeps domestic fuel prices very low, using a high level of subsidies, this will jeopardize fiscal gains achieved in recent years, and foreign exchange reserves are beginning to slip as the Government attempts to avert a heavy depreciation of the rupiah. The investment pickup is expected to support full-year GDP growth of 5.7%, revised up slightly from ADO 2005 and above the 2004 growth rate.

The Lao PDR is expected to post 7.2% growth in 2005, a little higher than forecast in ADO 2005. The economy is benefiting from expansion of gold and copper mining, the start of work on the important Nam Theun 2 hydropower project, and growth in the services and tourism industries. The Government softened the impact of higher oil prices on consumers by reducing the excise tax on gasoline to 2.5% from 12%.

In Cambodia, an expanded coverage of national accounts to include more of the informal sector and improved data sources mainly explain the sharp upward revision in the growth forecast to 6.3% for 2005, plus upward revisions to actual growth over the previous 2 years. Also, Cambodia's garment-exporting industry has not suffered as much as expected from the end of quotas under the Multifibre Arrangement. Tourism and construction are doing better than anticipated, but a drought in early 2005 reduced growth in agriculture.

Myanmar's economic performance in 2005 cannot be assessed because of a lack of timely and reliable data. However, the country's parallel exchange rate has continued to weaken, moving to MK1,080/$1 in July compared with the official exchange rate of about MK6/$1.

Inflation in Southeast Asia has been faster than expected in 2005. One cause is higher fuel prices. Countries that subsidize domestic fuel--including Indonesia, Malaysia, Thailand, and Viet Nam--have raised fuel prices to varying degrees, while Thailand ended subsidies on diesel and gasoline. Bad weather in the first half pushed up food prices in Cambodia, Philippines, Thailand, and Viet Nam. The forecast for average inflation in 2005 is revised to 5.1%, up by nearly 1 percentage point from both the ADO 2005 projection for this year and from the actual inflation rate in 2004. Inflation in a higher range of 7-8% is expected in Indonesia, Lao PDR, and Philippines. An easing of restrictions on rice exports from Myanmar, plus higher costs of fuel and an increase in civil service salaries, could push that economy's inflation rate back into double digits.

The subregional current account surplus in 2005 is revised down a half percentage point to 5.7% of GDP. This change follows a switch in Thailand's trade and current account from surpluses to deficits, the first since the Asian crisis. Current account surpluses remain large in Singapore (26.0% of GDP) and Malaysia (12.7%). Cambodia, Lao PDR, and Viet Nam continue to run current account deficits, which are expected to be covered by official development assistance, FDI, and, for Viet Nam, remittances from Vietnamese living abroad.

Growth in 2006 is projected to pick up in many countries in the subregion. The average rate is expected to increase by 0.4 percentage point to 5.4%, though this would be slightly below the ADO 2005 forecast. Cambodia, Lao PDR, and Viet Nam are likely to record growth in the 6-8% range. Indonesia, Malaysia, Philippines, Singapore, and Thailand are seen as expanding in the 4.7-5.9% range.

The revival in investment in Indonesia is expected to continue, but faster growth next year depends on the authorities following through with improvements to the business environment and tackling the politically difficult issue of huge fuel subsidies that are eroding the budget. Investment spending is also projected to rise in Malaysia, underpinned by the expected recovery in the global electronics cycle, new oil-field development, and a revival in public investment as the Ninth Malaysia Plan gets under way. Thailand will also be boosted by public investment as the Government's "megaprojects" investment program builds up steam. The program could provide a direct addition to GDP of about 0.7 percentage point a year, plus significant additional indirect stimulation through the multiplier effect. The Government has also introduced an economic stimulation package.

In the Philippines, a tightly constrained fiscal position will limit public investment. The expected uptick in growth in 2006 is based on a likely recovery in the global electronics cycle as well as increased remittances from overseas workers, which will support consumption spending. Singapore, too, will gain from stronger electronics orders. Its domestic demand is expected to pick up following moves by the Government this year to revive the property market and approve major casino projects.

Southeast Asia's current account surplus is projected to decline in 2006 to 5.2% of its GDP, the lowest level in 8 years and slightly below the ADO 2005 forecast. Stronger levels of investment (requiring imported capital equipment), the higher cost of oil, and, possibly, some real exchange rate appreciation will help bring down the surplus.

The subregional inflation forecast for next year is revised up by 1 percentage point to 4.9%, putting it close to this year's expected rate. As a consequence both of continuing inflationary pressures and of US interest rate rises, monetary policy could well be tightened in most economies. Malaysia, having adopted a managed float of its ringgit against a basket of currencies in July 2005 and having seen the currency firm a little, has signaled that any further appreciation will be gradual.

The Pacific

The sharp rise in global oil prices is having divergent impacts on the Pacific economies. For the two oil exporters, Papua New Guinea and Timor-Leste, prospects have improved. For the other Pacific countries, the increase has negative implications for economic growth, inflation, and external balances, since most of them are remote and import-dependent, relying on oil products for their air and sea connections to the rest of the world, and for their electricity generation.

The growth forecast for Papua New Guinea, the biggest economy in the Pacific, is revised up slightly to 3.0% for 2005, after 2.6% growth in 2004 (Figure 1.8). The increase in part reflects strong world prices for the country's exports of oil, copper, gold, and agricultural products, including coffee and cocoa. Credit to the private sector increased by 17% over the first 5 months of 2005, a reversal of a downward trend since 2001. This suggests that macroeconomic stability achieved in 2004 is having a positive effect on business confidence.

Merchandise exports rose by 6% in the first quarter of 2005, led by gains in oil and copper. Imports surged by 28% as more equipment was bought for the oil industry. A widening of the trade gap led to a current account deficit for the quarter, which, combined with a capital account deficit, resulted in the balance of payments moving into deficit. Gross foreign exchange reserves totaled $608 million at the end of the first quarter, equal to about 4 months of total imports. Inflation in the first half of the year was low at 1.2%, and is expected to average 2.8% over the full year. The kina was steady against the US dollar but depreciated a little against the Australian dollar.

The improvement in Papua New Guinea's fiscal position last year continued into 2005. The budget in 2004 is now estimated to have been in surplus by the equivalent of 1.7% of GDP, compared with an originally budgeted deficit of 1.5%. As of May 2005, the budget surplus was 1.8% of GDP, attributable to higher revenues from oil and mining.

The country's growth prospects for 2006 are revised up to 3.4%. New mines are likely to come into production, while the prospects have improved for a proposed natural gas pipeline to Australia. Conditional sales contracts were signed with Australian gas buyers earlier this year and a decision on whether to proceed with the pipeline is expected in 2006. Inflation is expected to average 3.4% next year.

In Timor-Leste, the other Pacific country to benefit from higher oil prices, revenue from oil production helped boost net foreign assets by $97 million to $284 million in the first quarter. This is the equivalent of 95% of annual non-oil, non-United Nations GDP and more than 15 months of projected imports. Moreover, the governments of Timor-Leste and Australia in July reached agreement on dividing royalties from oil and gas reserves in the Timor Sea. The Government has established an oil fund to manage the oil revenue for the long term. However, unemployment is high and 40% of the population live below the poverty line.

A moderate recovery got under way in 2004 in the non-oil economy. In the first quarter of 2005, bank lending to the private sector rose by 10% from the fourth quarter of 2004, indicating that the recovery continued into this year. Inflation in the first quarter was 3.5%. International financial and technical support is winding down. IMF forecasts are for GDP growth of about 3% in 2005.

In contrast, the near- and longer-term outlooks for the Fiji Islands, the subregion's second-largest economy, are clouded by higher oil prices, as well as by an adverse impact from the ending of US garment quotas under the Multifibre Arrangement at the start of the year. The GDP growth forecast for 2005 is revised down slightly from ADO 2005 to 1.4%, less than half of the growth rate achieved in each of the past 3 years. The garment industry, a major export earner, has been hurt more than was expected by the cessation of US quotas. At least one of the country's major garment makers has significantly reduced production and 3,500 jobs are expected to be lost in the industry by the end of September. Total exports dropped by about 37% in the first quarter from a year earlier, with reduced receipts from sugar, garments, fish, and gold. Imports fell by 4% as a result of a contraction in purchases of consumer goods, but the full-year forecast for imports is revised up because of rising prices for imported fuels.

On the plus side, tourist arrivals in the Fiji Islands rose by 13% in the first quarter from a year earlier and the value of building work, mainly on nonresidential private-sector projects, almost doubled in this period. The Trade and Investment Bureau received investment applications for projects with a value of $660 million in 2004, nearly double the $360 million of 2003. Many of the proposed investments are in tourism-related projects.

Inflation, running at 2.8% in the first half, is projected at 4.5% in 2005, revised up from the ADO 2005 forecast because of higher fuel and domestic transportation costs. The budget deficit in June was 0.8% of GDP, well within the target of 4.6% of GDP. Official foreign reserves in July were the equivalent of 4 months of imports of goods and nonfactor services (using an expanded definition of reserves that, according to the Government, followed IMF guidelines).

GDP growth in the Fiji Islands is expected to weaken to just 0.8% in 2006 as a consequence of an expected further decline in the garment industry and a likely contraction in sugar, which provides direct employment for more than 10% of the labor force and is the second-biggest export product. The European Union has deferred a planned cut in the subsidized price that it pays for sugar from the Fiji Islands by 1 year, but it still intends to reduce the price by 39% over the period 2006-2010.

Elsewhere in the Pacific, private demand is showing positive signs so far this year, although data are scarce. In the first 5 months of 2005, credit to the private sector increased by 14.5% in the Solomon Islands, by 5.5% in Vanuatu, and by 5.4% in Samoa. In Palau, domestic tax revenue for the fiscal year that ends on 30 September is expected to increase by about 16%, a reflection of firm domestic demand and employment. The money supply grew by 13% in Samoa, by about 9% in Solomon Islands, and by nearly 5% in Vanuatu in the 5 months to May.

Inflationary pressures have generally been moderate in the smaller countries, but price pressures are likely to pick up in the second half as a result of higher oil costs. In June, inflation was just 1.7% in the Cook Islands, 2.5% in the Marshall Islands, 3.5% in Palau, and below 6% in Solomon Islands. Inflation was about 10% in Samoa and Tonga earlier in the year because of high food prices caused by bad weather, although those elevated prices are subsiding. Exchange rates were relatively stable against the currencies of major trading partners. External balances, too, are likely to suffer in the non-oil-exporting countries in the second half because fuel typically accounts for 10-15% of total imports and a substantial component of transportation costs.

The importance of tourism to the Pacific has increased substantially in recent years, supported by a consumer shift to safer destinations, improved marketing, and the entry of low-cost air carriers to some islands. Record tourist arrivals are expected in 2005 in Cook Islands, Fiji Islands, and Palau. However, growth in this industry may be difficult to maintain, given the rising cost of jet fuel and the constraints in some countries of limited accommodation and other infrastructure.

Rising fuel prices, to the extent that they are passed on, will hurt other industries as well, particularly those that are significant consumers of electricity, because most countries use diesel to generate power. Increasing fuel prices will flow through to higher costs for manufacturing and services industries. Several countries provide subsidies on transportation to their outer islands, so their budgets may be affected.

Public enterprises that use petroleum products, such as power generators and bus operators, have been constrained in some economies from passing on the full cost increases, with the consequence that their earnings will erode, or their losses increase. Public sector debt in some countries is reaching levels where governments will not or cannot borrow. Combined with chronically underbudgeted capital investment, this has led to underinvestment in productive infrastructure and maintenance. The underinvestment pushes up production costs and increases expenditure on substitutes (e.g., private generators instead of the public utility) as well as capacity constraints (in, e.g., transport networks).

As a way to replace some imported fuel, the Fiji Islands and the Marshall Islands are considering the manufacture of ethanol from sugar for use in vehicles, and the conversion of coconut oil into coco-diesel to power generators and other engines.

There are indications of improved fiscal management in countries that have had a weak record in this area, including Fiji Islands, Papua New Guinea, Solomon Islands, and Tonga, but these improvements need to be sustained before it is clear that the situation has reversed. Similarly, several countries are preparing structural economic reform packages, with an emphasis on improving the performance of their civil services and public enterprises, as well as the environment for the private sector. However, governments have not yet taken the tough decisions associated with implementation. Further, progress on reforms may well be affected by the election schedule of the next 2 years, which includes Fiji Islands, Samoa, and Solomon Islands (in 2006), and Papua New Guinea (in 2007).

Back Risks	Next II. Economic trends and prospects in developing Asia